Shocking oil prices?

Based on ‘The Economist’ article, “Not so shocking”, April 30th 2005

Does the price of oil matter any more?

The price of a barrel of oil has risen from $10 to $50 but has not caused any economic shock. The conventional idea of rising oil prices having a great impact on the economy has not been applied in today’s world.

Ken Rogoff, a professor at Harvard said that a rise in price of an oil to $80 “would not present any great difficulties for the global economy”. If the rise happened over five or ten years, consumers would switch to more energy efficient substitutes. Since demand for oil is not very elastic, a change in price will not have such a great impact on the quantity of oil demanded.

During the oil price hike in the 1970’s, it was a time of high inflation, wage and price indexation and economic malaise. But the economic outlook today is hugely different with low inflation and a strong demand led growth.

Another reason why the price in oil has not had such an influence is because more OECD countries have become less energy intensive, due to the shift away from manufacturing to services. For example, America uses only half as much oil per unit of GDP as it did 30 years ago.

But rising oil prices will be hurting poorer countries more. They are more dependent upon imported oil and use energy far less efficiently than rich countries as they try to make a dash for manufacturing-led growth.

Two lessons are clear from the “non-shock” of 2004. First, the world’s reliance on petroleum makes it vulnerable to shock in oil prices. Second, comparing prices in absolute terms can be misleading, as costs have to be adjusted for inflation. So oil price is still important but it’s just that $50 isn’t what it used to be.