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How big is the 2011 oil price shock?

Guest post by: Carl Moore

Article Overview: Each of the last five major downturns in global economic activity has been immediately preceded by a major spike in oil prices. Sometimes (e.g. in the 1970s and in 1990), the surge in oil prices has been due to supply restrictions, triggered by Opec or by war in the Middle East. Other times (e.g. in 2008), it has been due to rapid growth in the demand for oil.

How big is the 2011 oil price shock?

But in both cases the effects of higher energy prices have eventually proven too much for the world economy to shrug off. With the global average price of oil having moved above $100 per barrel in recent days - about 33 per cent higher than the price last summer - it is natural to fear that this latest oil shock may be enough to kill the global economic recovery. With global oil supply already impacted by Libyan shut-downs, the threat of an oil shock has moved well beyond the realms of the theoretical. According to recent reports, about half of Libya's 1.6m barrels per day of oil output have been knocked out. Total Libyan oil production is less than 2 per cent of the world total, and it is of course most unlikely to be lost on a permanent basis. According to the head of the oil division at the IEA, the current level of IEA reserves is 1.6bn barrels, which could be used to supply an extra 4m barrels a day for a whole year if needed. On top of this, the potential extra production capacity among Opec producers is variously estimated at between 4 and 6m barrels a day. True, some analysts claim that it would be extremely difficult to bring this potential output on stream rapidly, and others argue that it would not directly substitute for the types of crude produced by Libya. But it is surely very hard to deny that oil stocks are generally in much better shape than they were when prices rose to over $145 per barrel in 2008. And Opec spare

capacity is about twice what it was then, even on a pessimistic read. Since the Saudis have already started to step up production in recent months, and since they will need more oil revenue to pay for the extra government spending which was announced, there seems to be sufficient available supply to offset the output disruptions so far.However, political contagion in the Middle East is taking on a life of its own, and the original assumption that there would be a firewall between the populous, oil-poor economies like Egypt, and the much richer oil producers in the Gulf, seems shakier by the day. How far would oil prices have to rise before the upswing in the global economy would be seriously threatened?

It is important, though, to remember that none of these effects would do much damage unless they were expected to last for quite a long time. Otherwise, consumers would just dip into their savings to finance what they expected to be temporary increases in energy expenses. Therefore the severity of any oil price shock should be judged not only by the size of the short term spike in oil prices, but also by its duration.

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Article Tags: Banker, Construction Funding, Equity, FHA Financing, oil prices, real estate values



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