Return of high oil prices threatens real damage

Return of high oil prices threatens real damage

By Jeremy Warner Economics Last updated: October 20th, 2009


Interest rates at close to zero are driving the price of virtually everything else wild, so it should come as little surprise to see oil back above twelve month highs. OK, so it is still a long way from the crucifying $140 a barrel it reached in the summer of last year, but prices have nearly doubled so far this year and at more than $80 a barrel, they are again high enough to cause real economic damage.

By common agreement, it was the collapse of Lehman Brothers which plunged the world into deep recession, and no doubt the destruction of confidence in the banking system was a major cause. But what’s often over looked is the role played by high energy prices. These had reached crippling levels by the summer of 2008, and were causing real damage to industry and business. American consumers took one look at prices at the pumps and collectively decided to stop spending. This collapse in consumer and business confidence preceded the Lehman debacle.

The world economy is said to be a great deal less vulnerable to high oil prices than it was 30 or 40 years ago, but they still self evidently have the power to shock. Most post war recessions have been preceded by a spike in the oil price. So to see the price back at elevated levels (see accompanying chart) before a proper economic recovery has even taken hold is a cause for some concern.

Having peaked in the summer of last year at over $140 a barrel, the oil price then plunged. But now it is back up to over $80.

In part, today’s relatively high price is merely a function of dollar weakness. Abdallah El-Badri, Secretary General of OPEC, insists that there is no shortage of oil. The rally to more than $80 a barrel is driven by higher equity prices, the sliding dollar and speculation”, he told Bloomberg News.

There are plainly fundamental forces at work too. Emerging market economies, particularly those of China and India, are once more booming. Yet I suspect the main mischief is again speculation. With interest rates at close to zero, you cannot get a return on cash right now, so money is being poured into riskier assets, including commodities and oil.

An interesting article in the Financial Times this morning puts the near term upward pressure on oil prices down to heavy trading in options contracts ahead of the year end. Quite a lot of this activity is driven by forward hedging for real economy clients. But there is also a significant amount which is purely speculative in nature.

Is it right that speculators should once more be putting the health of the world economy at risk? Speculation, it is often said, only reflects underlying realities. The speculator only makes money if his bets mirror the real economy pressures of supply and demand. Maybe, but cheap money in the quantities now being provided by central bankers and governments creates distortions which stand to upset these delicate balances.

If the price gets back to $100 or more, a double dip recession in advanced economies would seem a virtual certainty. They are all still too fragile to be able to tolerate such a rise in costs.


Tags: Abdall El-Badri, banking crisis, Lehman Brothers, oil, oil price spikes, OPEC, recession, speculation

http://blogs.telegraph.co.uk/finance/jeremywarner/100001422/return-of-high-oil-prices-threatens-real-damage/?utm_source=Telegraph.co.uk&utm_medium=TD_oil&utm_campaign=Finance2110