Those of us born in the late 1970s have a great advantage when it comes to understanding today’s oil market: we cannot remember Opec embargoes, nor the double-digit inflation and bitter recessions they triggered. So while many of our elders and betters were predicting Armageddon as the price of oil climbed inexorably over the past couple of years, we younger ones took the surge in our stride — rightly, as it turned out.
There is little doubt that the black stuff will soon cost at least $100 a barrel, while a litre of petrol routinely tops £1. But the British and global economies have changed so much over the past 40 years that they can now handle it. This is not to say it will be painless; merely that these days, other economic shocks — especially anything that affects the credit and banking systems — matter far more.
A recent modelling exercise by the International Monetary Fund to gauge the effects of a doubling in oil prices showed world growth slowing at worst by 1.4 percentage points before returning to normal after two years. Inflation would rise by a maximum of 1.5 per cent, though the spike would only last five months. All of which would be eminently bearable, and helps explain why the world economy is still doing nicely despite a 63 per cent rise in the oil price to its peak this year.
Oil can go up for two reasons: supply may be restricted — which is what happened in 1973 and 1979 — or demand can surge. The good news is that the broader and more flexible world economy of today is much better able to cope with a gradual, largely demand-driven increase in the price of oil.
Shocks to supply remain, usually when strikes, hurricanes or fires knock out refineries, or when the market starts to worry about a new war in the Middle East. But all of this pales in comparison with the ever larger demands for oil from emerging economies in Asia. Net imports by China and India are expected to jump from 5.4 million barrels per day in 2006 to 19.1 million in 2030, more than the combined imports of the US and Japan.
Demand will continue to grow faster than supply next year. The International Energy Agency expects global demand to rise from an estimated 85.9 million barrels per day this year to 87.7 million in 2008; but supply is forecast to come in at 85.2 million barrels per day in 2007 — a shortfall of 700,000 barrels. The gap widens to 2.4 million barrels per day in 2008, effectively guaranteeing that $100 a barrel will be the new norm.
All of which confirms that the rising price of oil is a result of economic success, especially in Asia, rather than the cause of economic failure, as it was 30 years ago in the West. For all its credit-crunch problems, the world economy enters 2008 in not too sickly a state; by contrast, it was so weak in the 1970s that it did not take much of a shock to cripple it. Another crucial difference is that Western economies are far more reliant on services than they ever were in the past; this means they are less affected by the prices of commodities, including oil.
The slump in the value of the dollar, in which oil is priced, also partly helps to explain the rise in its price. Producers have seen the value of their exports drop in real terms as the greenback has plummeted; there has been huge pressure to jack up prices in compensation. The surge in the euro against the dollar has helped protect the eurozone, cancelling out much of the rise in the price of oil. Sterling’s performance against the greenback has also helped. In the aggregate, the British economy, which still pumps out roughly as much oil as it consumes, gains as much as it loses from higher oil prices.
Yet another big change since the 1970s is that central banks have grown up. They know they must act speedily to nip inflation in the bud; interest rates are guaranteed to go up if higher commodity prices begin to feed into consumer prices, which is one reason why overall inflation has been almost entirely unaffected by the surge in the price of fuel over the past few years.
Finally, in many countries including Britain, sky-high petrol taxes act as a cushion: the price at the pumps has gone up proportionately much less than it has in America, where lower taxes mean that market prices are reflected much more closely at the filling stations.
So what next? Jim Rogers, the investor who predicted the start of the commodities rally in 1999, is now forecasting $150 a barrel. When he first came up with his prediction a year ago, he was dismissed out of hand. Nobody’s laughing today. But one thing is clear: unlike in the 1970s, the world economy will be able to cope with almost anything the oil market throws at it.