Oil prices rose significantly during 2010, with Brent crude beginning the year at $77.93 per barrel, and ending it at $94.38; an increase of 21%.
During January the price rose further and has been close to breaking the symbolic $100 per barrel barrier.
There is considerable unhappiness in Scotland about the high prices of petrol and diesel, particularly in rural areas. The latest CPI inflation figure is 3.7%, which is well above the Bank of England’s official target of 2%, and that will increase pressure on the bank to increase its base interest rate from the current 0.5%.
There seems increasing awareness, however, that about 70% of the retail prices are taxes imposed by the UK Government, so the world price of crude is not the main reason for the high prices.
In the last few days, the IEA has warned about the negative impact of high oil prices on world economic growth. There are various reasons for the price rises, including rising demand for oil in China and other countries, very cold weather in much of the northern hemisphere, a further fall in the value of the US dollar and, most recently, the political turmoil in Egypt.
I believe that many of the comments about the negative impacts of high oil prices have been superficial, and that there are more sensible economic explanations. For example, exchange rates make a big difference. Crude oil continues to be priced in US dollars but the value of the greenback, and also Sterling, has fallen substantially since the financial crisis hit the US in late 2008. Thus for most countries there have been much smaller price rises in their own currencies.
Secondly, oil’s share of the overall energy market has fallen significantly in recent years, particularly because it is now rarely used for electricity generation. There has been a big switch to alternative fuels, especially natural gas, even a revival in coal-fired power stations, plus renewables of course.
Consumers have been responding to high oil prices, although that can take a few years when major capital investments are required, such as new power stations.
Thirdly, oil and other energy prices are heavily subsidised in many countries, including China and India, which have been at the forefront of the recent growth in world energy demand. Consumers in many developing countries – possibly most – have therefore been largely protected from the recent price rises.
Two years ago, I did a study for the Egyptian Government and the World Bank on the economic implications of subsidised energy prices – mainly gas in this case.
One of the main conclusions was that the consumption of gas and other fuels was much higher than it would be if world market prices were applied, which should not be surprising.
I made various recommendations for phasing out the subsidies over a period of time, but the latest political events in Egypt suggest that it will be a few more years before most of my recommendations are implemented.
I also do not expect any short-term changes in the subsidy regimes in countries such as China. In many developing countries subsidised energy prices are social policies akin to unemployment benefits and old age pensions here. It will take many years of economic development before such policies can be changed.
Fourthly, oil-producing countries have benefited massively from the rise in oil prices. How they spend the additional oil revenues can have a positive impact on world economic demand.
The ostentatious spending in the likes of Dubai may not be a good example of that, but the sovereign wealth funds in the Middle East and elsewhere are now very important investors in the UK and other developed countries.
Thus, I believe that the IEA and other bodies are exaggerating the negative impact on world economic growth. When these factors are taken into account, the impact has been surprisingly small, and I expect that to continue to be the case for the next year or two.
Consumer outrage about high petrol prices in Scotland is being fuelled by the political situation in advance of the Scottish Parliamentary elections in May.
In reality, petrol and diesel prices are a very small proportion of most businesses’ and individuals’ weekly spending.
For many businesses it is a mixed picture, because higher fuel costs may be more than offset by greater exports.
And demand in the UK is now insignificant in comparison with China and India. There is little we can do to influence the level of world oil prices.
Tony Mackay is MD of economists Mackay Consultants
