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Here’s What Oil at $70 Means for the World Economy

Rising oil prices are a double-edged sword for the world economy.

With the price of crude up about 18 percent this year and now trading at the highest since 2014, exporters of the fuel get to enjoy a windfall while consuming nations get hurt.

Much ultimately depends on the reason why prices are pushing higher. An oil shock on the back of constrained supply is a negative though higher prices due to robust demand may just reflect solid global growth.

Either way, there are winners and losers, especially among emerging economies. Countries who rely on imported energy will be squeezed as costs go up, balances of payments become strained and inflation accelerates. For exporters, government coffers will get a fillip.

U.S. President Donald Trump’s plan to withdraw from the 2015 accord to curb Iran’s nuclear program poses fresh uncertainty although Bloomberg Economics reckons that and similar supply shocks account for half of oil’s recent rise.

The commodity extended gains above $71 after government data released in the U.S. Wednesday showed a surprise drop in crude inventories.

1. What does it mean for global growth?

The world economy is enjoying its broadest upswing since 2011 and higher oil prices would drag on household incomes and consumer spending, but the impact will vary. Europe is vulnerable given that growth and industrial activity already are moderating and many of the region’s countries are oil importers. China is the world’s biggest importer of oil and could expect an uptick in inflation — prices already are tipped to increase 2.3 percent in 2018 from 1.6 percent in 2017. For a sustained hit to global growth, economists say oil would need to push higher and hold those levels. Seasonal effects mean energy costs often increase during the first half of the year before easing. Consumers can also switch energy sources to keep costs down, such as biofuels or natural gas.

2. How will Iran impact the the market?

Oil prices have risen 14 percent this year — half of this increase reflects stronger global demand, a Bloomberg Economics model suggests. The rest is likely due to heightened tensions with Iran and other supply shocks. The return of U.S. sanctions could crimp Iranian oil exports, but the global supply shock might be mitigated by increased pumping elsewhere, according to the analysis. Here’s a chart.

3. Who wins from higher oil prices?

Most of the biggest oil-producing nations are emerging economies. Saudi Arabia leads the way with a net oil production that’s almost 21 percent of gross domestic product as of 2016 — more than twice that of Russia, which is the next among 15 major emerging markets ranked by Bloomberg Economics.

Other winners could include Nigeria and Colombia. The increase in revenues will help to repair budgets and current account deficits, allowing governments to increase spending that will spur investment.

4. Who loses?

India, China, Taiwan, Chile, Turkey, Egypt and Ukraine are among those on the worry list. Paying more for oil will pressure current accounts and make economies more vulnerable to rising U.S. interest rates. Bloomberg Economics has ranked major emerging markets based on vulnerability to shifts in oil prices, U.S. rates and protectionism.

Analysts at RBC Capital Markets created an “oil sensitivity index” to judge the economies most exposed in Asia. They warn that Malaysia, Thailand, China and Indonesia could face the most volatility from an oil-price spike.

5. What does it mean for the U.S. economy, the world’s biggest?

A run-up in oil prices poses a lot less of a risk to the U.S. economy than it used to, thanks to the boom in shale oil production. The old rule of thumb among economists was that a sustained $10 per barrel rise in oil prices would shave about 0.3 percent off of U.S. GDP the following year. Now, says Mark Zandi, chief economist at Moody’s Analytics, the hit is around 0.1 percent. And that all but dissipates in subsequent years as shale oil production is ramped up in response to the higher prices. The Baker Hughes U.S. rig count already is at a three-year high.

As the U.S. nears the tipping point between net oil importer and exporter, some forecasts are less upbeat. Gregory Daco, the U.S. chief for Oxford Economics, estimates that if WTI crude prices average $70 a barrel this year, U.S. growth will lose half the 0.7 percentage point gain it would otherwise earn from tax cuts passed earlier in 2018.

Oil-producing states such as North Dakota, Texas and Wyoming should benefit from higher extraction activity, though Daco warns that productivity enhancements could limit that upside. Poorer households have the most to lose. They spend about 8 percent of their pre-tax income on gasoline, compared to about one percent for the top fifth of earners.

6. Will it lead to higher inflation around the world?

While the influence of energy prices in overall consumer price baskets varies widely by economy, the category claims a double-digit share in economies such as Indonesia, Malaysia and New Zealand, according to RBC Capital Markets tallies.

Energy prices often carry a heavy weight in consumer price gauges, prompting policy makers including those at the Fed to focus simultaneously on core indexes that remove volatile food and energy costs. But a substantial run-up in oil prices could provide a more durable uptick for overall inflation as the costs filter through to transportation and utilities and other associated industries.

What Our Economists Say:

“Pass-through from oil prices to inflation is less than it used to be. At a country level, the oil share in the energy mix, degree of slack in the economy, and use of price controls and subsidies all modulate the impact.”
— Tom Orlik and Justin Jimenez, Bloomberg Economics

7. What does it mean for central banks?

If stronger oil prices substantially boost inflation, central bankers on balance will have one less (big) reason to keep monetary policy on hold while the Fed moves ahead in its tightening cycle.

Among the most-exposed economies, central bankers in India could have a big headache from a surge in crude oil prices. Alongside sharp weakness in the rupee, economists already are pushing forward their forecasts for the Reserve Bank of India’s interest-rate increases as India’s biggest import item gets more expensive.

Greater overall price pressures also could prompt faster monetary policy tightening in economies such as Thailand and Indonesia, which otherwise have used benign inflation as among reasons to stay patient on interest rates.


4 Comments on "Here’s What Oil at $70 Means for the World Economy"

  1. Outcast_Searcher on Fri, 11th May 2018 7:18 pm 

    If oil gets high enough, it’s good for green energy around current prices.

    It’s obviously good for the oil industry and those who serve it. Doomers were shrieking that low oil prices were the end of the world for the oil industry. That was obviously nonsense, but it will help companies in debt pay that off, as big profits continue if higher prices persist.

    To the extent that moderately higher inflation rates bring an end to the artificial zero interest rates and return some normalcy to a growing global economy, that should also be a good thing.

    Normal interest rates should be a very good thing for savers like retirees who don’t want a large portion of their money in the stock markets, due to short term risk there.

    The main risk I see is if things get out of hand, and inflation heads into high single digits, spurring an “inflation mentality”, bringing more inflation like in the 70’s in the US.

    As long as inflation remains moderate, as the energy intensity of GDP decreases, there are more winners than losers.

  2. Dooma on Fri, 11th May 2018 9:57 pm 

    The world economy is not growing. Wage stagnation is happening around the world, and the difference between the disappearing middle classes and the rich have never been this great.

    What we are witnessing is the most significant theft of the world’s resources to benefit an entitled few. With absolutely no thought given to future generations who are going to inherit a destroyed ecosystem. And we allow them to get away with it.

  3. Davy on Sat, 12th May 2018 12:47 am 

    OS, it is pretty obvious there is a goldilocks range and that range is compressing slowly over time. Peak oil dynamics are alive and well and slowly compressing the range at which everyone is healthy. Personally I think prices around where they are now are good. I would like to see renewables and their cousins the EV’s and hybrids continue their expansion. Efficiency efforts are hitting diminishing returns but slowly. Many sectors and many nations have room for improvement that over time will help alleviate peak oil dynamics.

    It is not at all clear where inflation and interest rates are going because we are in a new normal of central bank management. With debt so high in all sectors there is little room for business cycles as we once had without more extreme consequences. There has been a compression here also. We have been spreading risk throughout the system with debt and distorted price discovery because of low interest rates and liquidity easing. We now have sectors and nations that are very sensitive to interest rate swings. We are seeing this effect with the dollar and emerging markets. Who says we are going to have normal interest rates. I will believe it when I see it. That day may never come again. What we see now is a stealth wealth transfer because of these range bound rates.

    What is real inflation today? With price discovery distorted by rate repression and liquidity easing it is difficult to see this clearly. Some areas are already bad. Go to the store or buy a meal and you definitely see it. Buy some things like a TV and it is not as bad. I don’t see much decrease in energy intensity per GDP. This is another area of diminishing returns. Renewables will help some. Efficiency in some areas will help. Overall most aspects of our modern world are compressing. We are pushing limits and we are nearing boundaries of stasis meaning our habituated stability is not guaranteed. The trend is not healthy but at least we are generally stable. Our geopolitical is a mess and dangerously close to major disruptions with trade and proxy conflicts. There are winners and losers but more are losing than are winning in aggregate these days IMO.

  4. Dredd on Sat, 12th May 2018 7:30 am 

    Here is what Oil-Qaeda melting glaciers will do to the economy (On Thermal Expansion & Thermal Contraction – 34).

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