ANALYSIS-Recession risk unless oil prices fall further

Fri Aug 12, 2011 1:26pm GMT
 

* Oil cost relative to GDP well above affordable level
    * Oil price x consumption / GDP "critical" above 5 pct
    * Previous breaches of 4.5 pct have brought recession
    * Oil prices must fall far, fast -- and then stay low

    By Christopher Johnson and Claire Milhench	
    LONDON, Aug 12 (Reuters) - If history is any guide, another
oil-induced recession may be just around the corner, at least
for the United States and some of the other developed economies.	
    Every time that the cost of oil relative to global economic
output has hit current levels -- and that's even after sharp
falls in spot prices this month -- it has heralded a slump.	
    And while economists and analysts say a serious slowdown can
still be avoided, many add that unless oil and energy prices
fall much further and -- most important -- stay down, the world
economy could be in serious trouble.	
    "We are in a danger area for the world economy," said
Christophe Barret, global oil analyst at Credit Agricole.	
    The warning signal flashing is what economists call the "oil
expense indicator": the share of oil expenses as a proportion of
worldwide gross domestic product (GDP) (oil prices times oil
consumption divided by world GDP).	
    Since 1965, this has averaged roughly 3 percent of GDP, and
it has only exceeded 4.5 percent during three periods: in 1974,
between 1979 and 1985 and in 2008.	
    Each period has seen severe global recessions.	
    In 1973/74, during the first global "oil shock", oil prices
rocketed after an Arab oil embargo in response to an
Arab-Israeli war disrupted oil flows and triggered panic buying.	
    In 1979, revolution in Iran knocked out much of the
country's oil output and was followed by a long Iran-Iraq war,
bringing a second "oil shock".	
    In 2008, propelled by a housing bubble, speculative buying
of new debt instruments and a commodities boom, oil prices
exceeded $100 per barrel for the first time and soared to a
record high above $147, helping trigger financial crisis and the
worst slump since World War II.    	
    	
    	
    "DRAG"	
    This time, oil prices have soared following the loss of
around 1.6 million barrels per day (bpd) of Libyan oil,
uprisings across the Middle East and North Africa and rapid
economic growth in China, India and other developing economies.	
    Using the oil expense indicator, economists say Brent crude
LCOc1, the international oil benchmark, would need to be in
the low $90s per barrel to be under the 4.5 percent danger mark.
   	
    In fact, Brent hit a two-and-a-half-year high of more than
$127 per barrel in April and, with the exception of an intra-day
dip on Tuesday, has been over $100 for six months.	
    Even after a fall of more than $20 from its early-August
high on worries over a slowdown in the developed economies,
Brent is still not far off $110 per barrel.	
    Oil is a key global cost because it is crucial to every part
of the economy, powering manufacturing and the production of
food and other commodities, fuelling transport as well as being
a building block for industries such as plastics and
electronics.	
    If it is too high for too long, the results are dramatic.	
    "The last two times that energy as a share of global GDP
neared ... the current level, the world economy experienced
severe crises: the double dip recession of the 1980s and the
Great Recession of 2008," Merrill Lynch analysts led by
Francisco Blanch said in a note to clients.	
    Economists reinforce their warnings over the possibility of
an impending slowdown with data showing that oil demand has
begun to shrink in some countries in response to high prices.	
    	
    LEADING INDICATOR	
    Oil data lags, but the latest U.S. figures, for May, show a
drop of 4.7 percent year-on-year in U.S. gasoline demand.  	
    Deutsche Bank analyst Adam Sieminski says he is concerned by
a trend towards lower U.S. oil demand evident since last summer:	
    "The last time U.S. oil demand was falling was in 2007 and
early 2008," Sieminski said in a note written with analyst
Michael Lewis. "This was a leading indicator of the economic
troubles that would hit the U.S. in the middle of 2008."	
    Analysts differ on exactly how high oil prices need to be
and how long they need to stay up before they slow growth. Some
economists argue the impact of oil prices has been exaggerated,
and others note that not all recessions are caused by oil, such
as slowdowns in the early 1990s and again a decade later.	
    But most economists argue there is a level at which fuel
input costs become incompatible with continuing economic growth.
 	
    James Zhang, an analyst at Standard Bank, says the danger
level comes with the oil expense indicator at around 5 percent:	
    "$100 per barrel represents about 5 percent for the 'oil
expense indicator', which we think would be a threshold on an
annual average level to potentially kill off global growth," he
said.	
    "Absent any shocks, I don't believe an oil price, say in the
range of $100 to $130, will necessary bring a recession itself,
but a slower growth is almost ensured -- another sharp jump in
oil prices could act as a shock," Zhang said.	
    Barret said record high oil and commodity prices were
putting unsustainable pressure on household expenditure, and
while he like other economists is reluctant to predict
recession, he thinks the warnings should be heeded:	
    "There is still a chance that oil prices will go down very
significantly, and that could be a strong support to the
economy. But if prices stay near $110 per barrel until the end
of the year, we will have a major problem by the start of 2012,"
he said.	
    "We either get sharply lower prices or a recession that will
bring down prices. Either way, oil prices must come down."	
	
 (Additional reporting by David Sheppard in New York; editing by
Jane Baird)

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