Will rising oil prices choke off the economic recovery?

by Dr. Lynn Reaser

Unrest in the Middle East threats to derail the economy just as it seemed that business and consumer confidence was on the mend.  The uprisings in Tunisia, Egypt, and Libya could lead to the overthrow of more regimes in the region.  The risk has two dimensions.  First, higher oil prices could dampen consumer spending, raise inflation expectations, and hurt company profits.  Each $10 rise in oil prices could knock about 0.3% off GDP growth.  Second, spreading revolt would hit financial markets, particularly stocks.

The impact on consumer spending of higher oil prices is significant.  Each $1 increase in the price of oil typically translates into a 2-1/2 cent increase in the price of gas at the pump.  In turn, each one cent hike in gas prices costs households about $1 billion over a year’s period of time.  To bring it down to a personal level, a one-dollar increase in the price of gasoline would cost a driver another $20 to fill the tank of a small SUV, which is about what the average worker earns per hour before taxes.

The outcome of the current turmoil in Libya is impossible to predict.  Colonel Gaddafi’s ability to stay in power is probably limited, but the exact duration is uncertain as is what kind of governing body might succeed him.  A period of chaos after the dictator’s demise might also ensue.

Disruption to Libya’s oil production is already taking place as foreign companies withdraw their workers.  However, Libya’s 1.6 million barrels of daily oil production only accounts for about 2% of the world’s total oil supply.  Saudi Arabia has already pledged to offset the loss of Libya’s 1.3 million barrels of daily exports (primarily to Europe) with its spare capacity of around 3.7 million barrels.

The major risk, which has shaken financial markets, involves Saudi Arabia itself.  Yet, the Saudi regime has implemented some reforms, distributed large parts of its oil wealth, and faces a fragmented opposition.  A continued escalation of oil prices to $150 a barrel and beyond caused by rebellion or anarchy in Saudi Arabia is a possibility but unlikely.


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