TheTreasurer

Should we worry about rising oil prices?

The upswing in the price of crude may be painful in the short term, but is unlikely to derail growth, says Kallum Pickering

No primary input matters more than crude oil.

Changes in the price of a barrel of oil can occasionally have large effects on real incomes and economic activity. The advent of US shale since 2013/14, which added to global oil supply and sharply lowered oil prices and global inflation, has been a major boon for households. The drop in the oil price helped to jumpstart consumption growth and bolstered the global upswing we are enjoying now.

The oil price has trended up during the past 12 months, from c.$50 for a barrel of Brent crude to a current price of around $76. The rise towards $70 was mainly due to strong global demand and an effective effort by the Organization of the Petroleum Exporting Countries to constrain its own production.

But growing tensions in the Middle East, centred on US President Donald Trump’s decision to withdraw the US from the 2015 Iran deal, have pushed the oil price up further.

Should we worry about the latest rise in the oil price? No. At least not much. When the economic backdrop is strong, demand growth typically remains resilient as the oil price rises. Yes, a sudden rise in the oil price to, say, $100 per barrel, as some market commentators predict, would be a cause for concern. But that seems unlikely.

A more modest rise to, say, $80 or even $85 a barrel, could begin to show up in consumption growth over the next year or so. But, as most major economies are currently growing above their potential rates, this is not a huge worry.

As long as tensions between Saudi Arabia and Iran do not escalate far beyond the current proxy wars in Yemen and parts of Syria, and the Strait of Hormuz remains open, current events are unlikely to disrupt the global oil market severely.

Alternative oil producers

The higher price should mean more supply, eventually. Other oil producers should be able to compensate for any potential decline in the c.4% of global oil output that Iran currently supplies.

As global oil supplies are more price-elastic in the age of fracking than before, prices may come down a bit towards the end of 2018, as the higher price makes more oil sources profitable and production rises.

When fundamentals are healthy, we can live with the occasional headwind. The advanced world is in a better shape now than it was before the financial crisis. There are few signs of excess.

Consumption growth is driven by rising incomes rather than borrowing. Firms are investing more in response to stronger demand and capacity constraints.

The modest rise in the price of oil is not yet one of the risks that could destabilise the momentum behind the current upswing much. Instead, we have to watch out for the potential tail risks from the threat of escalating trade wars.

The misguided attempt by President Trump to fix US trade deficit by slapping tariffs on the US’s trading partners risks far more damage to the economic upswing than say, an extra 10 or 20 pence on the pump.

Kallum Pickering is senior UK economist at Berenberg Bank

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