Editorial comment
Financial Times.com
October 7 2006
SourceIt has been quite a while since the world last heard some good news on oil prices. In the space of a few weeks, crude prices have fallen by 20 per cent, to about $60 a barrel. Most will presume this development is positive for the world economy. On closer inspection, however, the news may signal a more disturbing event: an upcoming slowdown in economic activity across the industrialised world.
Only three years ago oil prices were hovering around the $30 mark. Since then, we have seen a steady increase in prices on the back of strong oil demand, a sluggish response in supply and the spike in prices caused by Hurricane Katrina this time last year. At its peak this August, crude oil was trading at just below $80 a barrel.
The recent easing in prices seems to be a good thing: cheaper oil reduces inflation. It does so directly, as headline price indices include some oil-related goods. There are also indirect benefits: businesses using oil as an input can lower the price of their own production, and consumers will revise down their expectations of future inflation, as fuel prices are so visible.
But that is not the whole story, as analysis of the causes of the doubling in oil prices shows. The main driver has been sustained growth in oil demand. That, in turn, has been the result of four years of exceptional economic growth. In 2004, the year oil consumption took off, global growth reached its highest rate since the 1970s.
Remember that the price of oil is closely related to demand (and vice versa) in the short run. The US has recently been the single largest contributor to world demand growth, thanks to substantial fiscal and monetary stimuli since 2001. Growth has been sustained by consumers, buoyed by a booming housing market and, more recently, by corporate investment. But the outlook for 2007 is tainted by an already noticeable moderation in the housing market, which Ben Bernanke, Federal Reserve chairman, this week warned could spill over into other sectors. Indeed, closely watched job creation statistics released yesterday showed the weakest reading since the one-off dip due to the hurricanes last September.
One can also not presume that other large economic regions will pick up the global growth baton. In the eurozone, the recovery that started early this year was primarily the result of strong export growth. Some of this impetus will disappear when US consumers realise they cannot extract yet more equity from their homes to buy another German car. While some countries have seen strong domestic demand, most obviously in Spain and France, a hawkish European Central Bank is bent on avoiding the slightest rise in inflation. At the same time, all the big European countries have decided to tighten fiscal policy. Meanwhile, Japan, where the current improvement was also originally due to strong external demand, is not big or buoyant enough to prop up world growth.
The reduction in prices we see today is the result of expectations of weaker demand rather than of improvements in supply. This makes the fall much more worrying than it may initially seem. If the decline in prices were to continue, it would be an indication of continued weakness in global demand. Worse, it would also undermine the price stability needed for investment in both increased supply and more efficient use of the world's scarce energy resources. Do not cheer too soon. This good news may yet turn out quite bad.
Copyright The Financial Times Limited 2006