How high can oil go before it derails economic growth? Dave Shellock. FT.com. London: Mar 1, 2011.
Significant quote: "The combination of a substantial run-up in demand coupled with a very severe supply shock makes a 'spike and crash' scenario increasingly likely for global oil prices and the world economy.
The sharp spike in oil prices sparked by turmoil in Libya, and the accompanying sell-off in global equities, has abated. But crude, at well over $100 a barrel, remains volatile. Should investors be fearful of the risks to the global economy?
Francisco Blanch, head of global commodity research at Bank of America-Merrill Lynch, warns that the disruption in Libya could be the eighth largest supply shock since 1950. "Worryingly, the oil infrastructure in Libya sits on the eastern side of the country and could be prone to attacks by either Gaddafi loyalists or opposition forces, creating the risk of a prolonged output loss," he says.
"Furthermore, with other countries like Algeria, Syria, Yemen or Saudi Arabia scoring highly on social discontent, the risk of continued tensions in the region remains high. Opec's total spare capacity is now down substantially - so the oil market's ability to deal with further bouts of unrest in the Middle East remains limited.
"The combination of a substantial run-up in demand coupled with a very severe supply shock makes a 'spike and crash' scenario increasingly likely for global oil prices and the world economy.
If Brent crude holds at around $110-115 a barrel in 2011, energy as a percentage of GDP would remain close to record levels, suggesting that the point of demand destruction is in short sight."
Robert DiClemente, economist at Citi, notes that, although oil prices had already been rising on the back of a strengthening global economy, the latest spike represents a supply-related risk premium with potentially less benign implications for US growth if not arrested or reversed in a reasonable timeframe.
"While declines in Treasury yields last week highlighted that inflation is not perceived as the dominant threat to economic stability arising from relative price shocks, there are other indirect risks from the unrest abroad.
"Setting aside the direct effects of higher oil prices on real spending power and reduced economic efficiency, the spillovers to financial conditions could by themselves undermine recovery at a delicate point when financial headwinds have been abating and the broader economy has been demonstrating hints of self-sustaining momentum," he says.
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Walter Derzko
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