Fear for oil supply

The world is on the verge of an oil-driven economic crisis to rival those of the 1970s and 1980s, experts say.

Yesterday oil continued to trade above $US130 and certain brokers were predicting that it could hit $US200 within 6 months. If this were to be then the economic picture of Australia and the rest of the world would be somewhat different than previously projected.

Rampant inflation, sharply rising unemployment, mass bankruptcies of individuals and businesses and high interest rates are just some of the consequences if oil hits $US200 a barrel.

Yet that's where many experts think the price of oil is heading, possibly as soon as next year and the world is on the precipice of an oil driven economic crisis as occurred in the 1970s and 1980s

What has caused oils meteoric rise?

First, non-OPEC producing countries, which account for about 60 per cent of world production, have flatlined for the past three years and appear unable to produce any more oil to satisfy the extra demand.

These producers include the US, Norway, Mexico and Russia, which is now the largest oil producer apart from Saudi Arabia.

Meanwhile, OPEC, which accounts for the other 40 per cent of production, says it is unwilling or unable to increase production cash in on the high price or whether its reserves are running out.

In addition, Saul Eslake, chief economist at ANZ, says another, underestimated factor is that subsidised fuel in many developing economies is keeping the price artificially high.

"In many developing economies, consumers are not feeling the effects of the higher prices because of government subsidies and that is keeping demand and therefore prices higher than they should be.

"The way the market is supposed to work is that high prices dampen demand, but that isn't happening to the same degree as it should.

Add to that worries about war and political instability in many oil-producing countries like Nigeria the weak US dollar, and you have the ingredients for the next "oil crisis''.

The weak US dollar is contributing in a major way because oil is priced in US dollars. So, as the dollar weakens, oil producers increase the price to make up for the fall in the currency.

Chief economist at AMP Capital Shane Oliver said families in Australia were suffering and it could get worse.

"The pace of the price increase is accelerating and the worst-case scenario is, we hit $US200 in six months' time,'' he said.

"That would be a crushing blow for many Australian families who are already struggling with high mortgage rates and rising fuel costs.

"I think we are getting to a critical point now. The world is spending about 7 per cent of GDP on oil - the same amount as in 1980 before the global slump.

"Crucially, if high fuel prices start imparting inflation throughout the economy - through higher transport costs leading to higher prices in the shops, for instance - in addition to families clamping down on their spending because of high fuel bills and mortgage payments, then we could be on the verge of an historic slump, which we will look back on in a similar way to the global slowdowns of the 1970s and early 1980s.''

As Mr Eslake said: "There is a point at which the oil price will be the straw that breaks the camel's back, in economic terms. And the fallout could be disastrous. But nobody knows where that point is.''

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Published on May 5-rd, 2008 in Insurance
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.
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