The oil price has been creeping up steadily in recent months and at the end of January it breached the $100 a barrel level for the first time since 2008. Since the crisis in Libya, it has reached $108 a barrel. Although that’s still some way off record levels of almost $150 a barrel we saw in 2008, it’s high enough to cause jitters.
The rise should give us pause — not least because, as the Guardian‘s economics editor Larry Elliott has noted, each of the four major recessions since the early 1970s have been preceded by a leap in oil prices.
According to Paul Stewart, managing director of Plexus Asset Management, the price increase is due to a number of factors.
“Besides the steady improvement in the global economy that has led to increased demand, the first recent spike was caused by the turmoil in North Africa, with Egypt President Mubarak refusing at first to step down and causing 18 days of violent protests,” he said.
Economies are now feeling the pressure of higher oil prices seeping through to their inflation-targeting measures. They’re forced to raise interest rates when it would be better to keep them as low as possible. The developed world’s economies are sluggish and desperately need more of a boost.
Investments in alternative energy sources
Oil-producing nations say they need a price of roughly $95 per barrel to make a return on their investment.
“But they are also wary of letting the price get too high as this will damage the recovering economies that are consuming their product,” Stewart said.
Leading analyst Charles T Maxwell, who has more than 50 years of experience in the energy business, has some bad news.
“Oil is heading towards $300 a barrel by 2020,” he says. This is simply as a result of supply and demand issues, as he sees oil production peaking in about five years. Also weighing heavily is the fact that currently there are no real alternatives. Some countries have already started to invest in alternative energy sources.
“The US has pumped big investments into ethanol developments to produce alternative energy sources,” says Stewart. “Other governments are following suit, with the Welsh being the most recent to announce such an investment.”
According to a report on Walesonline.co.uk, the world currently consumes 30-billion barrels of oil in a single year. It also states at least half of the planet’s total oil reserves have been used up in the past century while the world’s population has shot up from two-billion to almost seven-billion in 80 years. It mentions that experts believe that without oil the world can only support two-billion people — almost five-billion less than today’s population. It is forecast that the world’s population will reach eight-billion by the year 2025.
‘Not the time to go overweight’
The impact of high oil prices is also noted by professor of economics at New York University’s Stern School of Business, often-right but almost always gloomy Nouriel Roubini, who is quoted in the Financial Times as saying: “The recession that began in 2008 was caused not only by the Lehman Brothers insolvency but also by the fact that oil prices had doubled in the previous 12 months.”
The 2010 oil burden as a percentage of global GDP was at 4,1%, still below that of 2008 (5,1%), and already the second highest following a major recession (the highest was reached in 1980, at 8%). According to the International Energy Agency, undercurrent assumptions for global GDP the global oil burden could rise to 4,7% in 2011, getting close to levels that have coincided in the past with a major economic slowdown.
In Stewart’s opinion the recent combination of higher oil prices, together with a still sluggish recovery in the global economy, inflationary pressures and instability i n the Middle East, paints a dark picture. “For this reason we continue to advise investors to follow a somewhat cautious approach towards equity allocation. Now is not the time to go overweight,” he says.
How might all this affect South African consumers? According to Stewart, the rising cost of crude oil will directly impact local producer inflation and, ultimately, the consumer down the road. This is because the cost of production (especially in agriculture) and transport costs will spiral.
“South Africans have been protected from a large part of the rise in oil prices over the past two years due to the improvement in the rand versus the major developed market currencies. If the devaluation trend re-emerges due to heightened risk concerns over the Middle East and North Africa, South Africa may be in for a period of cost push inflation,” Stewart warns. And higher interest rates will doubtless follow a period of sustained inflation.
Stewart says that equity markets are not anticipating any interest rates hikes, so any news flow that would change the market’s opinion about how soon and by how much short-term rates may rise might potentially affect the valuation at which equity markets may trade.
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