Surge in the price of oil is a fresh threat to recovery

Author: By Sean O’Grady, Economics Editor

In its latest review of the oil market, the international body said: “The recent price spike, if further extended, risks derailing the recovery. Not only that, but oil demand itself would rebound much more slowly were the price rally sustained into 2010.” Oil, currently around $79 a barrel, has risen by about 75 per cent this year. The IEA also said that indications of renewed economic growth remained “tentative”.

“If prices keep rebounding, there’s a risk to the global economy as a whole, even to some of those economies in the Far East and even the Middle East,” added David Fyfe, the head of the IEA’s oil industry division.

A mixture of higher demand ? especially from still-vibrant emerging economies such as China and India ? and constricted supply is responsible for the latest upward pressure on prices.

The IEA say that global demand is projected to improve in 2010 to 86.2 million barrels a day, 500,000 barrels a day more than in last month’s report. That stands against an estimated average of 84.8 million barrels a day in 2009, which was in turn 1.7 per cent or 1.5 million barrels less than last year. Growth in China is set to rise as a result of stimulus-related infrastructure spending and is possible for much of the growth. A modest forecast rise in demand for oil in the US is thought by the IEA to be “uncertain”.

“It would seem that the ‘real’ US economy, as opposed to the financial one, is struggling to recover, despite the end of the recession,” the IEA said. Even so, the agency expects global oil demand to grow in the fourth quarter of this year ? the first time that will have happened since 2008.

World oil supply remains constrained by continuing political uncertainties around Iraq and other parts of the near east, and by a fall in investment in exploration and production after the oil price collapsed during 2008.

If the oil does spike again then it will inflict considerable damage to the advanced economies, and on the UK in particular. Although Britain still produces oil from the North Sea, it has been a net importer of oil over the past few years, and whatever small gains are made in the oil sector and for government revenues are usually far outweighed by the rising costs of energy to industry and domestic customers.

Even now the rise in commodity prices is also threatening to undermine the bank of England’s attempts to revive the economy through a combination of ultra-low interest rates and a £200bn programme of “quantitative easing” ? injecting money directly into the economy.

The Bank can only continue with this strategy if it can be confident that imported inflation ? from a combination of weak sterling and raised import costs ? did not threaten to push inflation back over the 2 per cent official target sooner than expected. Such an external shock has not been heavily factored into the Bank’s calculations so far, but could leave the authorities facing a nightmare combination of inflation and stagnant output ? “stagflation”.

The price of oil has more than doubled since its low points of around $32 a barrel last December, to about $70 now. However, it remains some way below the peak it reached in July 2008 of $147 a barrel. Gold is at all-time highs of about $1,100 an ounce, while other commodities, from tea to copper have also been testing fresh highs.

Opec reported earlier in the week that they have taken some 4.2 million barrels per day out of production since the recession sent oil from an all-time high of $147 per barrel to less than $30 in five months. Opec next meets to discuss the issue in Angola shortly before Christmas.

The cartel issued a similar outlook to the IEA a few days ago: “The low base in world oil demand in 2009 is suggesting a stronger increase in oil demand growth for 2010. However, a potentially weak economic recovery along with higher oil prices are the two main factors that may dampen world oil demand in the coming year.”

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