High oil prices kill growth prospects

The price of Brent oil reached $122 per barrel last week (April 6th) and JP Morgan have forecast that it will hit €130 in the next few months. Energy prices at these levels mean that Ireland can say goodbye to any hope that it can grow its way out of its debt crisis.

Because government spending cuts mean that domestic demand is almost certain to fall the country’s only hope of increasing its national income is to earn more from overseas. That wiil be hard if the global economy is depressed but if the global economy grows, the world demand for energy, and in particular for oil, its favourite fuel, is going to grow too. As a result, the price of oil will increase because, now that the peak in conventional oil production has been passed, it is no longer possible to raise the world’s oil output to keep pace with increased demand.

The extra amount Ireland will have to pay for its oil will snatch away the extra income it was hoping its export growth would earn. Indeed, its import bill may rise by more than the increase in its export earnings and the economy could shrink rather than grow.

In 2010 when oil averaged about $85 a barrel, Ireland spent €4 billion on importing it. That’s €1000-worth for each person in the country. At the current price of $120 a barrel, consumers are going to have to pay one-third more than they did last year. The extra €1.35 billion Ireland will have to find acts as a tax. It takes away money that the government could have taken in tax itself and used to balance its budget. Or, put another way, Ireland would need to get a 2% reduction in the rate of interest it is to pay for the ECB/IMF bailout money to have the same effect. The extra sum nullifies the effect of a 1% rise in GNP.

It was calculations like these that led Ernst and Young’s version of the European Central Bank’s New Area Wide economic model to predict during February that if oil prices were to stay around $120/ barrel this year and next, the eurozone economy as a whole would only grow by around 1%. The Irish economy would not manage even that. With an oil price of €85 a barrel, the model predicts that Irish GDP will shrink by 2.6% this year before growing slightly (0.9%) in 2012. But, if the €120 price applies, the model says GDP will slump by a further 0.5% in both years. And at $150/barrel, GDP could fall by 0.6% in 2012. This would make the increasing interest burden imposed by Ireland’s increasing debt totally impossible to carry.

Other people have done similar sums for other countries. Fatih Birol, the International Energy Agency’s chief economist believes that oil prices began to threaten the global economy’s recovery when they passed $90 a barrel. He said in an interview in February that if the price averaged $100 a barrel this year, the US would have to spend nearly $80 billion more on oil imports than it did last year while the European Union would have to spend $76 billion more. The increase in US import costs would present a “serious problem for business and consumer confidence, which the U.S. economy desperately needs for sentiment to improve,” he said. The European Union was also at risk, he added, because “Europe is the weakest link in the chain of the global economic recovery.”

The price of Brent crude in the period up to mid-March.
The price of Brent crude in the period up to mid-March. The price averaged around $85 a barrel until last November. It has since risen by almost a half to around $120. This will cost Ireland an additional €1.35 billion a year.
James Hamilton, a professor of economics at the University of California, San Diego, has worked out that a $20-a-barrel increase in the price of crude oil pushes up US petrol prices by 50 cents a gallon. This costs consumers about $70 billion a year and knocks about 0.5% off the US growth rate.

It is irresponsible for the Irish government to behave as if conventional policies are still valid and that growth will enable the country to work its way out of its problems. Its default position should be that the economy will contract for the foreseeable future and it must draw up plans which will enable it, and the whole society, to cope.

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