EVERY TIME the oil price looks ready to lie down, up it pops again. A promise last week by Saudi Arabia to increase output provided only a brief respite. High prices, it seems, are here to stay.
Our definition of high prices, meanwhile, is ratcheting higher. The price of West Texas intermediate, the American benchmark, has risen to $46 a barrel (35 gallons), while Brent crude is above $42 a barrel. These are record levels, and represent a 50% rise since March last year, the start of the Iraq war.
Then, many hoped that prices would soon come down to $20 a barrel or less. A pessimistic view was that oil would remain at about $30. But $45 has been breached, and the price could go much higher still. Emergent, a hedge-fund manager, has been basing its strategy on $55-$60 oil for some time. CSFB, in a new report, warns that prices are likely to trade in the $50-$60 range, if only briefly, in the coming months.
The reasons for high prices are well known. Insecurity and insurgency in Iraq, which last week hit oil exports, have produced the opposite post-war effect to the one the optimists were expecting. Vast tracts of Iraq are unexplored, and one day the country may have the scope to increase oil output sharply; but not for a while yet.
Tight supply, in the Organisation of Petroleum Exporting Countries (Opec) and elsewhere, means prices are acutely vulnerable to rising demand from China and other fast-growing economies. The result is that any supply shock — actual or threatened, whether it be Venezuelan politics, Yukos’s problems with the Russian authorities or the fear of terrorist attacks in Saudi Arabia — has a disproportionate effect on prices.
In addition, the spike in prices has coincided with more than the usual soul-searching about the future of oil. Speculation about a so-called “Hubbert peak” for global production has intensified. Dr M King Hubbert was the American geophysicist who predicted in the 1950s that American oil production would peak about 1970, and was right. He also predicted, wrongly, that there would be a peak in global oil production in the mid-1990s. But some of his followers say a global Hubbert peak will be reached before 2010, while many others think it will happen in the next 30 to 40 years.
In the meantime, high oil prices are a reality. So why isn’t there more of a panic? After all, oil has been responsible in the past for inflation of more than 20% and, in consequence, deep recession. The Federal Reserve mentioned energy prices in nudging American interest rates higher last week, but central bankers generally have been fairly sanguine about its effects.
Oil barely featured in last week’s discussion about the Bank of England’s latest, very dovish, inflation report. If there is an inflation shock from higher oil prices, the Bank has not spotted it, implicitly endorsing the market’s view that only one more quarter-point rate rise (taking the base rate to 5%) will be needed.
The inflation report, in fact, gave a pretty good explanation for why the Bank is not that worried about oil. We are used to looking at the dollar price of oil. Converted to sterling, however, the picture is somewhat different. The sterling price of Brent crude, currently just over £23 a barrel, is not yet back to where it was in the mid-1980s. In real terms — adjusted for inflation — oil hit nearly £60 a barrel in 1979-80, and is thus well below previous peaks.
The Bank also pointed out that all advanced economies have become less sensitive to oil, Britain particularly so. The decline of heavy, energy-intensive manufacturing means that OECD countries use just over half as much oil for a given level of gross domestic product (GDP) as in 1970. In Britain the decline has been even more pronounced — the oil intensity of GDP is only 40% of what it was three decades ago. Just to be clear, this does not mean we use less oil now; it means that oil consumption has risen much more slowly over time than GDP.
Adding these two bits of information together produces an interesting result. For high oil prices to have the same effect on the economy as in the 1970s we need to adjust both for the fact that real oil prices were higher in the past and that economies were more oil-sensitive. I calculate that it would need an oil price of just over $200 (£110) to produce the same kind of inflationary and recessionary shocks as in the past. That would be uncharted territory and is not remotely on the agenda. According to CSFB, the highest-ever oil price, in today’s prices, was $95 a barrel in the late 19th century.
That does not mean higher oil prices have no effect at all. An exercise by Goldman Sachs suggests that $50-a-barrel oil prices, if sustained, would add 1.6% to OECD inflation. In Britain the effect would be modest, 1%, while in other countries it would be greater. Developing countries dependent on oil would be hit hardest. Another effect of dearer oil would be to reduce global growth, probably by 0.7-0.9 percentage points. In the context of a global economy growing at 4% a year, this is fairly minor.
Before we get too relaxed, however, there is another dimension. There was news last week that Britain’s trade surplus on oil disappeared in June, with the volume of oil imports exceeding exports for the first time in 11 years. We also learnt that British Gas had signed a £4 billion deal to buy liquefied gas from Petronas, the Malaysian energy giant, to replace diminishing North Sea gas supplies. The North Sea era is not over, but the end is in sight.
Tie that to official figures showing Britain had a record trade deficit in goods and services of £10.8 billion in the latest three months and the picture becomes more worrying. Add in the fact that, as the Bank pointed out, Britain’s share of world export markets is declining — sharply in some cases — and it becomes more so. Britain’s overall world market share has dropped by 30% in the past 15 years. Outside the EU, it has plunged 45%.
What this means is that we can no longer be as relaxed about the medium-term impact of high oil prices as when Britain was a large net exporter of oil. The more we import, the more that high prices will add to an already substantial trade deficit. The balance of payments has been the dog that hasn’t barked in recent years. But now it is starting to growl in the distance. And it may come back to bite us.
PS: Is Britain’s job market, until now a source of pride for the government and support for the housing market, taking a turn for the worse? That is the view of some observers. Unemployment among both men and women turned higher in the April-June quarter, according to the latest Labour Force Survey, pushing the jobless total up 27,000 to 1.44m.
Employment fell 53,000 to 28.3m over the same period, with manufacturing jobs down 102,000 to 3.37m. The number of people of working age classified as economically inactive has risen by 89,000 to a record 7.85m in the latest three months.
As always in the job market, the evidence is mixed. The claimant count — the old measure of unemployment — continues to fall, and dropped nearly 14,000 to 835,000 last month. Alongside record inactivity the number of people in full-time jobs, almost 21m, is also a record. The big gap in society is between households where everybody works and those in which nobody does.
It may be a little early to call the job-market turn. Economic growth is still strong. But the figures raise an interesting question. As we move into a phase of much weaker public-sector jobs growth, will the private sector take up the slack? Industry is still shedding jobs while the lion’s share of service-sector employment has been generated by the state. Unemployment isn’t about to soar but the best of the job market appears to be behind us.
