Rising Oil Prices - the Impact on the Global Economy

12.06.08

Recently, oil prices hit a new record of nearly $US139 a barrel. This is roughly double the levels a year ago, and nearly thirteen times above their 1998 low point.

We can all feel the pressure at the petrol pump, but what does this mean for the economy?

Globally

The ever rising world oil price is now posing a major threat to the global economic outlook:

• the threat to inflation is already clear and inflation rates in most countries are now running well above the levels they were a year ago – this in turn pushes up interest rates to higher levels than would otherwise be the case in the face of slowing economic growth.

• rising oil prices effectively create a ‘tax’ on consumers during a time of weak economic conditions, reducing consumer spending and therefore putting downward pressure on corporate profit margins – this in turn makes it hard for companies to pass off oil related cost increases.

While the US credit crunch and housing slump have not been enough to bring on a global recession (defined as global growth below 3% p.a.), a long-term trend of rising oil prices will certainly increase the probability of it occurring.

Domestically

For Australia, the rise in oil prices is not as bad as in many other countries because it has been accompanied by a general rise in commodities prices – this has boosted Australia’s national income, reflected in higher returns from resources shares, income tax cuts and lower import prices from the strong $A.

However, it is widely believed that this is being more than offset by higher interest rates, and perhaps more significantly, higher petrol prices. The average Australian will be spending an extra $1,000 a year on petrol at current levels on top of higher mortgage repayments, meaning their spending elsewhere will fall.

Share Markets

The surge in oil prices is great news for energy shares – oil producers gain the benefits of higher oil prices, and markets tend to view other energy stocks (e.g. industries involved in the supply of uranium, wind and solar energy/resources) as more feasible, price competitive alternatives.

But it is bad news for the rest of the market given the impact on profit margins, interest rates and consumer demand. Transport and consumer discretionary stocks are the most vulnerable.

It is likely that share markets are going to continue to find it tough going over the next few months. Asian countries and their share markets are particularly vulnerable given their greater reliance on imported fuel and the energy intensity of their GDP (e.g. heavy manufacturing industries throughout Asia, increased growth in building/infrastructure in China).

However, should oil prices fall back later this year as many expect, that should help share markets rally into the year end.