IMF Survey: Record Oil Prices Unlikely to Dent World Growth Much
IMF News, November 5, 2007
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- Authors: Kevin C. Cheng, Valerie Mercer-Blackman IMF Research Department November
- Published: November 5, 2007
Overview
- A confluence of geopolitical tensions, tight supply, and a weakening dollar has pushed oil prices to record highs.
- The spike could boost inflation and add to strains on low-income oil-importing countries.
- Overall, the impact on world growth is likely to be limited.
By Kevin C. Cheng and Valerie Mercer-Blackman, IMF Research Department, November 5, 2007.
Commodity prices and recent highs
- On November 2, the average petroleum spot price (APSP) set a new high, closing at over $91.
- Benchmark closing prices the same week:
- West Texas Intermediate: almost $96
- Brent: more than $92
- Dubai: more than $85
- Measured in euro and SDR terms, the surge has not been as stark, reflecting the depreciation of the dollar.
- Futures and options markets indicate:
- APSP will average over $87 per barrel in the fourth quarter of 2007
- APSP will average over $86 per barrel in 2008
- There is a more than one in four chance that Brent crude prices could be above $100 by early 2008
Drivers of the recent spike
- Triggering factors cited:
- Heightened geopolitical concerns about growing tensions along Iraq's border with Turkey
- Continued concerns about Iran
- Bad weather in the Gulf of Mexico
- Increasingly tight oil market conditions
- The weakening dollar
- Other commodities—precious metals, industrial metals such as lead and nickel, and foods such as wheat and edible oils—also set record highs during 2007, amplifying the broader commodity price surge.
Demand versus supply dynamics
- Oil demand growth is expected to remain robust throughout the rest of 2007, supported by strong growth in emerging markets, particularly China and the Middle East.
- Supply has lagged and inventories are falling:
- During the first nine months of 2007, world oil supply declined moderately by 0.1 millions of barrels per day (year on year), reflecting a decline in OPEC output and limited output growth outside OPEC.
- Commercial inventories in OECD countries fell in the third quarter, a period normally marked by inventory accumulation.
- Supply is unlikely to catch up with demand growth because of increasing technological and economic challenges for oil production.
- Tight market conditions are expected to persist and possibly intensify, assuming strong GDP growth continues in emerging markets.
The weakening dollar and investor behavior
- The dollar depreciation has amplified the oil price surge in dollar terms:
- APSP rose by almost 55 percent in dollar terms during the year ending October 2007
- APSP rose by about 36 percent in euro terms during the same period
- Apart from an "accounting effect," analysts suggest the weakening dollar and financial turbulence linked to the U.S. subprime mortgage market may have induced investors to diversify toward commodities as "alternative assets."
Likely macroeconomic impact
- Inflation:
- Rising oil prices will likely boost headline inflation in the months ahead, but only slightly.
- The direct effect of the recent oil price rise on headline CPI inflation in the United States is estimated to be about 0.1 percentage points by the end of the year.
- Greater monetary policy credibility has anchored inflation expectations more securely, particularly in advanced economies.
- Growth:
- The impact on global economic activity should be limited for several reasons listed by the IMF:
- The depreciation of the dollar has softened the impact on other major consuming countries.
- The price rise has been driven by sustained strong demand growth rather than supply shortfalls.
- Economies today are much less energy intensive compared with the late 1970s.
- In the United States, the low season of gasoline consumption during September-October has kept retail gasoline prices comfortably below the highs set in May 2006.
- Distributional effects:
- Emerging market and developing countries may face more challenging situations where overheating pressures exist.
- Rising fuel costs may put pressure on household budgets and external balances, particularly in low-income oil-importing countries.
Risk scenario and model-based findings
- A supply-driven spike caused by a serious deterioration of security conditions in the Middle East could have a significant impact on global growth.
- The April 2007 World Economic Outlook simulated a supply-induced oil price hike using the IMF's "Global Economy Model" and found:
- A sharp supply-induced rise in oil prices could result in a global slowdown.
- Income would be redistributed to oil-exporting economies, which have a lower propensity to spend than oil-importing economies.
- Higher oil prices would raise the cost of production and put upward pressure on the aggregate price level, prompting central banks to increase interest rates.
- Combined higher production costs and higher interest rates would further dent economic activity in the short run.
IMF Survey: Record Oil Prices Unlikely to Dent World Growth Much — Kevin C. Cheng and Valerie Mercer-Blackman, IMF Research Department, November 5, 2007.