蒙面歌王第六期摘星怪:Oil and the economy The 2011 oil shock

THE price of oil has had an unnerving ability to blow up the worldeconomy, and the Middle East has often provided the spark. The Arab oilembargo of 1973, the Iranian revolution in 1978-79 and Saddam Hussein’sinvasion of Kuwait in 1990 are all painful reminders of how the region’scombustible mix of geopolitics and geology can wreak havoc. Withprotests cascading across Arabia, is the world in for another oil shock?

There are good reasons to worry. The Middle East and north Africaproduce more than one-third of the world’s oil. Libya’s turmoil showsthat a revolution can quickly disrupt oil supply. Even while MuammarQaddafi hangs on with delusional determination and Western countriesdebate whether to enforce a no-fly zone (see article),Libya’s oil output has halved, as foreign workers flee and the countryfragments. The spread of unrest across the region threatens widerdisruption.

The markets’ reaction has been surprisingly modest. The price ofBrent crude jumped 15% as Libya’s violence flared up, reaching $120 abarrel on February 24th. But the promise of more production from SaudiArabia pushed the price down again. It was $116 on March 2nd—20% higherthan the beginning of the year, but well below the peaks of 2008. Mosteconomists are sanguine: global growth might slow by a few tenths of apercentage point, they reckon, but not enough to jeopardise the richworld’s recovery.

That glosses over two big risks. First, a serious supplydisruption, or even the fear of it, could send the oil price soaring(see article).Second, dearer oil could fuel inflation—and that might prompt a monetaryclampdown that throttles the recovery. A lot will depend on the skillof central bankers.

Of stocks, Saudis and stability

So far, the shocks to supply have been tiny. Libya’s turmoil hasreduced global oil output by a mere 1%. In 1973 the figure was around7.5%. Today’s oil market also has plenty of buffers. Governments havestockpiles, which they didn’t in 1973. Commercial oil stocks are moreample than they were when prices peaked in 2008. Saudi Arabia, thecentral bank of the oil market, technically has enough spare capacity toreplace Libya, Algeria and a clutch of other small producers. And theSaudis have made clear that they are willing to pump.

Yet more disruption cannot be ruled out. The oil industry isextremely complex: getting the right sort of oil to the right place atthe right time is crucial. And then there is Saudi Arabia itself (see article).The kingdom has many of the characteristics that have fuelled unrestelsewhere, including an army of disillusioned youths. Despite spending$36 billion so far buying off dissent, a repressive regime faces demandsfor reform. A whiff of instability would spread panic in the oilmarket.

Even without a disruption to supply, prices are under pressure from asecond source: the gradual dwindling of spare capacity. With the worldeconomy growing strongly, oil demand is far outpacing increases inreadily available supply. So any jitters from the Middle East willaccelerate and exaggerate a price rise that was already on the way.

What effect would that have? It is some comfort that the worldeconomy is less vulnerable to damage from higher oil prices than it wasin the 1970s. Global output is less oil-intensive. Inflation is lowerand wages are much less likely to follow energy-induced price rises, socentral banks need not respond as forcefully. But less vulnerable doesnot mean immune.

Dearer oil still implies a transfer from oil consumers to oilproducers, and since the latter tend to save more it spells a drop inglobal demand. A rule of thumb is that a 10% increase in the price ofoil will cut a quarter of a percentage point off global growth. With theworld economy currently growing at 4.5%, that suggests the oil pricewould need to leap, probably above its 2008 peak of almost $150 abarrel, to fell the recovery. But even a smaller increase would sapgrowth and raise inflation.

Shocked into action

In the United States the Federal Reserve will face a relatively easychoice. America’s economy is needlessly vulnerable, thanks to itsaddiction to oil (and light taxation of it). Yet inflation is extremelylow and the economy has plenty of slack. This gives its central bank thelatitude to ignore a sudden jump in the oil price. In Europe, wherefuel is taxed more heavily, the immediate effect of dearer oil issmaller. But Europe’s central bankers are already more worried aboutrising prices: hence the fear that they could take pre-emptive actiontoo far, and push Europe’s still-fragile economies back into recession.

By contrast, the biggest risk in the emerging world is inaction.Dearer oil will stoke inflation, especially through higher foodprices—and food still accounts for a large part of people’s spending incountries like China, Brazil and India. True, central banks have beenraising interest rates, but they have tended to be tardy. Monetaryconditions are still too loose, and inflation expectations have risen.

Unfortunately, too many governments in emerging markets have tried toquell inflation and reduce popular anger by subsidising the prices ofboth food and fuel. Not only does this dull consumers’ sensitivity torising prices, it could be expensive for the governments concerned. Itwill stretch India’s optimistic new budget (see article).But the biggest danger lies in the Middle East itself, where subsidiesof food and fuel are omnipresent and where politicians are increasingthem to quell unrest. Fuel importers, such as Egypt, face a vicious,bankrupting, spiral of higher oil prices and ever bigger subsidies. Theanswer is to ditch such subsidies and aim help at the poorest, but noArab ruler is likely to propose such reforms right now.

At its worst, the danger is circular, with dearer oil and politicaluncertainty feeding each other. Even if that is avoided, the short-termprospects for the world economy are shakier than many realise. But therecould be a silver lining: the rest of the world could at long last dealwith its vulnerability to oil and the Middle East. The to-do list iswell-known, from investing in the infrastructure for electric vehiclesto pricing carbon. The 1970s oil shocks transformed the world economy.Perhaps a 2011 oil shock will do the same—at less cost.