Commodities | Jul 04 2006
By Chris Shaw
Oil prices are again nudging their all time highs of around US$75 per barrel, once more raising the question of what impact a stronger oil price would have on inflationary pressures globally.
There seems little relief in sight for the oil price in the short-term, as brokers have continued to lift their price forecasts. Merrill Lynch was the latest to act, increasing its average price forecast for 2006 to US$67.50 per barrel from US$59.50. The broker’s forecasts have moved higher in future years as well, with 2007 now US$65 per barrel from US$47 per barrel previously and 2008 increasing to US$50 per barrel from US$42 per barrel.
Andreas Hoefert of UBS Wealth Management Research believes current concerns a higher oil price will spark higher inflation are somewhat overdone, as oil prices actually have far less of an impact on inflation and economic growth than was the case during the oil shocks of the 1970s.
It is a view shared by Saudi oil minister Ali bin Ibrahim Al Naimi, who while clearly talking his book to some extent said recently higher oil prices have not yet had any negative impact on global economic growth, an opinion difficult to argue with given economic growth around the world remains reasonably strong.
Hoefert suggests there are three reasons higher oil prices today are not flowing through into higher inflation, the first being the current strength is a reflection of stronger demand, rather than an abrupt and significant limitation on supply as occurred in the 1970s, when OPEC simply cut output. This means the impact, while still significant, is more gradual as prices have climbed steadily rather than jumping almost instantly.
Secondly, he points to increased globalisation as an important factor, as the ability of companies to lower costs means inflationary pressures have been kept in check far more effectively than when economies were more closed. Also, the effect of globalisation has made it more difficult to simply pass on cost increases, as Australian manufacturers such as Amcor (AMC) and PaperlinX (PPX) would attest. This means there is currently a battle between inflationary pressures such as higher energy prices and deflationary pressures such as lower wage costs (production in Asia), so inflation is lower than would have been expected based on historical comparisons of the oil price.
The final point he makes is oil is simply not as important to the global economy as was the case 30 years ago, as the oil-to-GDP ratio is now about half the level it was in the 1970s. This reflects more efficient production and consumption as well as some substitution into alternative energy sources, with the end result being a higher oil price is simply less inflationary.
This is not to say investors shouldn’t be concerned about inflation moving higher, as Hoefert gives reasons why this can still happen. The main reason is excess liquidity, as global liquidity has almost doubled since 2000. While this has yet to show up in the price of goods and may not given central banks such as the Bank of Japan are now attempting to reduce the liquidity within their economies and others such as the US Federal Reserve have already acted on, it remains a threat to move higher.
Before this has you scrambling for inflationary hedges, Hoefert points out a return to the double-digit inflation levels of the 1970s remains highly unlikely.