Economic strength, not supply squeeze, fuelling oil prices | South China Morning Post
  • Wed
  • Jan 28, 2015
  • Updated: 2:39am

Economic strength, not supply squeeze, fuelling oil prices

PUBLISHED : Friday, 09 September, 2005, 12:00am
UPDATED : Friday, 09 September, 2005, 12:00am

Call it the petroleum paradox. For the past two years or so, energy analysts have been warning that higher oil prices would hammer businesses around Asia, eat into incomes and crimp growth. In that time, the price of oil has doubled. But apart from some localised disruption, Asian economies and companies remain in robust health.


In April, when the Asian Development Bank (ADB) published its outlook for the year, its economists warned that every sustained US$10 rise in the price of a barrel of oil would knock the best part of a percentage point off Asia's growth rates. At the time, it assumed an average oil price for this year of US$41 a barrel, and forecast 6.5 per cent growth in developing Asia's gross domestic product. Yesterday, Brent crude was trading at US$63.60 a barrel and few analysts now expect an appreciable drop anytime soon. Goldman Sachs, for example, is forecasting prices in excess of US$60 for the next four to five years.


Applying the ADB's April rule of thumb, the US$20-something rise in oil prices since April should knock 1.6 percentage points off Asian growth, meaning the region should grow by just 4.9 per cent this year.


Yet, when the Manila-based institution announced its revised economic outlook yesterday, it actually raised its regional economic growth forecast for this year a tad to 6.6 per cent. China's expected growth rate was hitched up to 9.2 per cent, from 8.5 per cent back in April. Higher oil prices simply have not had the deleterious effect most economists expected.


One reason is that the original forecasts were based largely on the impact of the oil price spikes of 1973, 1979 and 1990, all of which were caused by reduced supplies, and led to recessions in the developed economies. This time, it is different. 'Pretty well all of this oil price rise is the effect of strong demand rather than supply cut-backs,' says Giles Keating, Zurich-based head of research at banking giant Credit Suisse.


In other words, the price rise is the result of economic strength. Even though prices are fast approaching their 1981 inflation-adjusted high, individual companies have been able to cope with higher energy costs because they are benefiting from stronger demand for their products. Unfortunately, this relatively benign situation may not last. Global oil demand is likely to average 83.7 million barrels a day this year, whereas daily supply in the first half of the year was 84.1 million barrels.


That, says ADB economist Frank Harrigan, is the lowest safety margin for 35 years, even without factoring in supply disruptions following Hurricane Katrina. 'The supply-side constraints are becoming quite acute,' he warns.


That threatens to change the whole game. If supply squeezes and refining bottlenecks begin to push prices up, rather than prices being pulled higher by demand based on economic strength, companies will be less able to absorb the extra energy costs.


There could be a positive spin-off for China, however, if higher crude prices spur the authorities to accelerate the dismantling of domestic fuel price controls. Although the oil price rose 30 per cent over the first seven months of this year, controls restricted the increases in pump prices for petrol to just 15 per cent, encouraging inefficiency.


'It is no way to run an economy. If China keeps going like that, problems will begin to build up,' warns Mr Harrigan. 'Really guys, you've got to think seriously about this.'


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