Higher oil price a headwind for the global economy

The oil price has been creeping up steadily in recent months and at the end of January it breached the $100 per barrel level for the first time since 2008.

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 most recent spike was caused by the turmoil in North Africa with Egyptian President Mubarak refusing at first to step down and causing 18 days of violent protests,” he says.

“Economies across the globe are starting to feel the pressure of the higher oil price seeping through to their respective inflation-targeting measures,” says Stewart. “This is putting pressure on them to raise interest rates at a time when most would like to keep rates as low as possible for as long as possible to boost their economies, which are still sluggish in the developed world.”

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,” adds Stewart.

Leading analyst Charles T Maxwell, who has more than 50 years’ experience in the energy business, has some bad news. “Oil is heading towards $300 a barrel by 2020,” says Maxwell. 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 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,” he adds.

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.

The impact of high oil prices is also noted by professor of economics at New York University's Stern School of Business, 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.”

Looking at the accompanying graph, 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 8,0%). According to the International Energy Agency, under current 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 in 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.