Saturday, July 15, 2006

Financial Times Editorial - Spooking the market

Financial Times Editorial - Spooking the market
Published: July 15 2006 03:00 | Last updated: July 15 2006 03:00
Copyright The Financial Times Limited 2006

It is hardly surprising the latest Middle East crisis has pushed oil prices to new peaks. For some time the balance of world oil supply and demand has been so tight that the market has responded to every bad piece of geopolitical news. Even if the fighting in Lebanon is not near big oil installations, any conflict involving Israel is capable of triggering incidents through the region. Yet there is still no reason to fear for the health of the wider world economy.

For, while oil prices have been rising, and hitting new highs, for more than two years, this is not because of any big supply interruption as happened in the previous two oil shocks of 1973-74 and 1979-81. Certainly, insurrection in Nigeria's delta region and instability in Venezuela have reduced output there. But production in these two big oil producers has not got any worse, though there is a growing worry about a third big producer, Iran, arising out of its mounting confrontation with the west over its nuclear programme. Likewise, there have been a couple of terrorist attempts on Saudi Arabia's vital oil facilities and continued jitters about more. But these fears have been around since 2001. Perhaps the most concrete threat to oil supplies is the prospect of another bad hurricane season in the Gulf of Mexico.

The most distinctive, and heartening, aspect of the post-2002 run-up in oil prices is that it has been demand-led. So, if the world economy is ticking over fast enough to keep drawing the oil price higher, it must be, by definition, so far relatively unaffected, though itis true China is still leading the growth in consumption. The International Energy Agency is predicting that China, together with the Middle East itself, will account for almost half next year's growth in world oil demand, though the Chinese economy accounts for less than 9 per cent of oil product consumption.

In contrast to the quicker and therefore sharper price spikes of previous oil shocks, the staggering of the oil price rises over the past four years has also helped dull its economic impact. This has happened in much the same way as a frog placed in a saucepan is supposed not to notice the gradual heating of the water. For its part, the world economy has seen little heating up of inflation. Greater competition in product markets and the tightening of monetary policy now under way have so far prevented oil prices feeding through into higher general inflation.

There is no doubt that the oil price rise has worsened global financial imbalances, increasing the import bill of such countries as the US and China which can afford it, but also that of many poor developing countries with weak balance of payments positions. Yet relative to today's world gross domestic product, private capital flows and financial markets, this oil-induced shift is far less of a shock than those in the 1970s. This may be why there has been less adjustment than in the past. Oil-exporting countries have been slower this time to import, while international oil companies have also been slower to reinvest their profits.

This seems to be because oil exporters and companies still seem distrustful that their current bonanza will last. This is not the view of the futures markets, which are predicting high oil prices into next year and beyond. If so, this would be a welcome boon to the increase in energy saving and development of fossil fuel alternatives that many industrialised countries are seeking. Perhaps the markets can deliver results that politicians cannot.


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