Two years ago, the ITEM Club from Ernst and Young peered into what at the time was the future, and made predictions on how it thought inflation and growth would be affected by the price of oil.
It looked at three scenarios. Scenario 1 was oil of around $50 a barrel; then it looked at the more-alarmist possibility of oil being priced at $65, and finally, for the sake of completeness, the highly unlikely doomsday-type scenario of oil breaching $100.
Its conclusion: if oil hit $100, inflation would rise to 4 per cent in 2006 and then fall back to 3.5 per cent in 2007. Whereas, if oil was priced at $50, it expected inflation to be bang on the 2 per cent target.
As for growth, if oil reached $100 it expected economic growth to be around a full percentage point less than if it was priced at $50.
But today, of course, that doomsday scenario seems a lot more likely. But, remember, oil has only been above $90 for the last few weeks. In fact since the ITEM club made its predictions, it has averaged around $65, and yet growth has been higher than the ITEM club expected under those circumstances, and inflation lower.
The UK has in part been insulated from the high price of oil by the falling dollar. But even so, at the exchange rate at time of writing, $98.96, oil costs £48. Back in July 2006, when it last spiked, there were a lot less dollars to the pound, but even so, oil was still a lot cheaper. On the 17 July 2006 the black stuff hit a then-record of $78.10. At the time there were 1.84 dollars to the pound, meaning oil was costing £42.40.
These days oil is not quite so important for the economy.
According to the Energy Information Administration, in 2006, energy took a 9 per cent bite out of GDP in the US, but in 1981, energy took up 14 per cent of GDP. According to David Wyss, chief economist at Standard & Poor’s, in 1980, the average American had to work 105 minutes to pay for enough oil to travel 100 miles. By 2006, he only had to work for 52 minutes.
Of course some believe oil will go crashing down, like it always used to. We are not so sure. Demand from the likes of China is set to continue to grow, while there have not been any major oil finds since the 1970s. The peaks and troughs of oil used to be determined by the business cycle. Now the high price of oil is surely down to the combination of permanent rises in demand, while there is less and less oil out there to be exploited.
In the medium-term, however, alternatives to oil could yet come on stream, which in turn will reduce demand, and who knows, maybe save the planet too. But right now, the only alternative to oil in common use, biofuel, seems to fail on many counts. For one thing it’s not very environmentally friendly. In Brazil, fuel grown from sugar cane often comes at the expense of deforestation. While fuel created from corn, as is popular in the US, requires almost as much energy to be created as it saves when used.
In any case, when food crops are used for fuel, the result is higher food prices and, right now, not only is oil up in price, so too is food.
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