Oil near $100

For the past few weeks, the international price of crude oil has been nudging the $100/barrel mark. This was postulated as a doomsday scenario even as recently as four years ago, when the price was just beginning to move up in the aftermath of the US invasion of Iraq in 2003. Dire predictions of a global meltdown were made but, on the whole, the scenario itself was dismissed as being highly improbable. The scepticism was reinforced when prices began to decline late last year. Now, all of a sudden, $100/barrel seems a possible reality. Ironically, however, a global economy that is already buffeted by the turbulence in the US housing and financial markets seems to be taking this rather nonchalantly. The outlook for growth and inflation around the world has changed marginally, if at all, and the stock markets which are supposed to indicate future business prospects seem to have completely shrugged off this development. Does all this reflect the insulation of economic performance from energy prices? Or, is everyone living in a fool's paradise, oblivious to the imminent downturn that such high oil prices are bound to precipitate?

There is little doubt that a significant degree of insulation has taken place. From the onset of the second oil shock in the late 1970s, the oil-intensity of global economic activity has steadily declined. Two factors are responsible: a significant change in the structure of the global economy, which has seen a shift away from manufacturing and towards services which, on the aggregate, are less energy-intensive; and, technological development and conservation practices, which have seen virtually all sectors becoming less energy-intensive. As a consequence, the impact of high oil prices on individual product costs and, through them, to cost-push inflation, is far less. As affluence has grown, the share of expenditure on energy in household budgets has declined; even as it rises again, it has not yet begun to exert significant pressure at the macro-economic level. Going forward, consumers will be able to achieve considerable savings by simple substitutions, such as in the cars they drive "" the collapse of the SUV market in the US and its impact on the finances of American auto majors are all too visible. Also, if prices persist at these levels, new sources of hydrocarbons, such as tar sands and shale, will become more viable, as will alternative sources of energy.

However, some of these opportunities will take time to materialise, and the short- to medium-term impact of prices at these levels could be considerable. China and India, besides being the fastest-growing economies in the world, are among the largest incremental consumers of oil. Both have stubbornly resisted passing to domestic consumers the full effect of global oil prices, a gap that is putting an enormous burden on both their oil companies and on government finances. If prices persist at these levels, Beijing and New Delhi will have to begin raising domestic retail prices. More broadly, from the perspective of emerging economies in general, the cost-push inflation will reduce the room for manoeuvre that central banks have to offset a possible US slowdown through an expansionary monetary policy. In that sense, high oil prices reinforce the negative impact of developments in the US economy. So far, however, there are very few (if any) indications of impending doom, but clearly no one should become complacent about the situation.