High oil prices and the economic recession

Tony Mackay

SOME people used to call me Dr Gloom because of my economic forecasts for the Scottish economy. I felt that was unfair because I have actually had an accurate forecasting record over the last decade and rarely been more pessimistic than the actual outcomes.

However, even I have become fed-up with all the gloomy articles about the state of the UK economy, the eurozone crisis, the share price of RBS and other problems. Many people blame high oil and gas prices for the economic recession in the UK and most of the European Union but I do not believe that is a realistic assessment.

High prices benefit producers and disadvantage consumers. The net effect could therefore be neutral, although it depends to some extent on what the former do with their increased revenues and the latter with their reduced incomes.

Despite the widespread complaints about high petrol and diesel prices, the official statistics show no reduction in demand in the UK. That is also the case in most of the EU. Consumers may be complaining but they have not reduced their energy consumption to any significant extent. The economic jargon is that energy demand is price inelastic.

There can be no doubt that high energy prices have had a negative impact on some parts of the Scottish and other economies but I believe that has been massively exaggerated. The UK now imports more than half its oil and gas requirements, so the high prices have massive negative implications for the balance of payments. However, if Scotland were independent we would still be net exporters.

High prices have helped revitalise the UK offshore industry, with about £15billion of investment now under way, notably west of Shetland on fields such as Laggan, Tormore, Clair Ridge and Schiehallion. That is of great benefit to the supply chain in Aberdeen and elsewhere.

Brent crude traded between $90 and $120 per barrel during 2011 and in the second half of the year was surprisingly stable at around $110. You might expect that falling economic growth would have had exerted downward pressure on prices but that has not happened and I foresee no significant decline during 2012.

Even with all the economic problems the International Monetary Fund estimates that world economic output increased by about 4% in 2011. World demand for oil and gas will have been lower at around 2%. Little of that growth has occurred in the UK and the rest of the EU but it is evident that countries such as China and India now have greater impacts on world prices than the EU and US.

Supply and demand continue to be important factors. The Organisation of Petroleum Exporting Countries (Opec) had a surprisingly successful 2011 in controlling supply to maintain prices over $100.

I have written in previous columns that Opec had a target price of $75 per barrel which was raised to $90 last year but little has been done by member countries to keep prices below the $100 threshold.

Saudi Arabia, in particular, seems content with current prices. It has managed to avoid the Arab Spring revolutions which have transformed Egypt, Libya and Tunisia, partly because of massive increases in public expenditure. The country probably needs $100 per barrel to balance its books over the next few years. Other Middle East countries such as Bahrain are in a similar situation.

There have also been a few special factors, such as the Fukushima nuclear disaster in Japan and the loss of Libyan oil and gas production. The former resulted in a substantial rise in Japanese oil imports and moves in other countries to reduce nuclear power, to the benefit of gas-fired power stations.

Libya is currently producing at about 35% of its pre-Arab Spring levels. Saudi Arabia has increased its output to compensate for the shortfall but in a way that has kept oil prices above the $100 threshold, and I expect that to continue during 2012.

There are likely to be politically worrying events during the year in countries such as Syria, Iraq and Iran, so in my opinion at least there is little reason to expect any significant falls in oil and gas prices in the near future.

In any case, as I mentioned earlier, the demand for energy in the UK and other European countries seems to be increasingly price inelastic.

There are long-run shifts in favour of wind energy and other renewables but in the short term most consumers have adapted by reducing expenditure on other items but not energy.

Further, domestic energy prices in fast growing countries such as China and India continue to be heavily subsidised, which results in higher consumption than would otherwise be the case.

Tony Mackay is the MD of energy economists Mackay Consultants

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