Experts

Should we worry about oil prices?

The risk of supply disruptions has fueled fears that oil prices will surge. What would the consequences be? Are such fears reasonable?

Date: Feb 10, 2012          Author: Paul Marson

Keywords: Oil, Commodities

The risk of supply disruptions has fueled fears that oil prices will surge. What would the consequences be? Are such fears reasonable?

Although not all oil price shocks historically led to recessions, all National Bureau of Economic Research (NBER) recessions are associated with an increase in the price of oil – oil prices have spiked at the onset of each of them, and the average real crude price during recessions has been 42% higher than in normal times.

Clearly, an exogenous oil price shock is rarely good news for oil-importing economies: increased prices act as a tax on consumers, create “bad” inflation (ie not related to a healthier economy) and slow growth. And the current economic climate makes increased investor vigilance with respect to a potential oil shock particularly justified.

With US households drowning in debt and savings rates very low, we cannot expect the private sector to maintain the same level of real spending should energy prices rise significantly (although all-time low gas prices could partly offset this). On the corporate side, higher oil prices would squeeze demand, raise input prices, weigh on margins – and are typically associated with widening credit spreads. Thus access to liquidity would be further restrained in already-tight credit conditions.

So, are investors’ fears of an oil shock reasonable?

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