A Crude Awakening?

I mentioned in my January newsletter that rising oil prices may throw the global economic recovery off course. These comments were written before the tumultuous recent events in Tunisia, Egypt, Bahrain and Libya, which have caused Brent and West Texas Crude prices to spike higher over recent weeks, with West Texas Intermediate Crude rising from $90 a barrel to $101. Speculation that OPEC could not increase production significantly to offset a suspension or severe disruption of Libyan oil production, coupled with fears that uprisings may be felt in neighbouring countries, notably Saudi Arabia or Bahrain, have driven prices higher. Libya is Africa’s third largest oil producer and reports from the International Energy Agency suggest that Libya produced 200,000 barrels of oil less than their usual quota last month.

The surge in oil price has been clearly visible at petrol stations and has led to concern that even higher petrol prices could be on the cards if the turmoil escalates. Chancellor George Osborne has hinted that the 1p rise in fuel duty pencilled in for 1^st April will be suspended, but this will do little to aid motorists who have been hit with three increases in tax (VAT and fuel duty) so far this year.

Whilst the immediate impact on individuals and families who need to spend more at the pumps to fill up is very clear, it is important to consider that the cost of transporting goods to their final destination or point of sale will also increase. The travel industry will also be hit, with some airlines already introducing fare surcharges (although this may have a small silver lining as more people choose to take holidays in the UK, thus boosting our own tourism).

The cumulative effect may well damage the fragile economic recovery and raise inflation higher still, putting further pressure on the Bank of England to raise interest rates (of which more below). Both the British Chamber of Commerce and National Institute for Economic Research have recently reduced their GDP growth forecast for 2011, although both fall short of suggesting the UK economy could be plunged back into recession. I would tend to agree that sluggish growth remains just the most likely scenario for 2011, but the chance of a double dip recession is certainly increasing. And if the price of Brent Crude oil sticks well above the $120 a barrel level for most of the year, the downside risks to growth will only increase.