Oil: a crude assessment?

It was Supermac, the 1950s Tory Prime Minister Harold Macmillan, who famously said it was “events, dear boy, events” which could blow people off course.
What’s happened in Libya during the past few days has certainly blown my theories about the impact of oil on inflation off course.
While rising oil prices were fingered several times as the culprit in the last UK inflation figures, I’d read that the Saudis had quietly been increasing production to help take the sting out rising prices. Hence my blog ‘Oil’s well with inflation’.
Well, for the moment you can forget that idea. Fuel prices are going up again, at least partly because of the decision to shut down some of the oil wells in beleaguered Libya.
This has set hares running about the possibility that prices will rise so much that we are in for an ‘oil shock’, a spike in the price which is so pronounced that it sucks the life out of economic recovery.
This would be scary stuff. The price of oil has already been rising because of massive demand among fast-growing economies like China, and an additional spike would be felt right in the pockets of people and businesses.
An excellent analysis by Gavyn Davies in the Financial Times suggests that is, if you’ll pardon the pun, a crude assessment.
He gives some useful facts. Libya’s oil production is less than two per cent of the world’s total, the International Energy Agency estimates there’s enough oil in reserve to supply more than double Libya’s output every day for more than a year, while the other OPEC countries have spare production capacity which exceeds even that. Indeed, Saudi Arabia is already in talks about increasing production again to try to take the heat out of any spike.
But the spike in oil prices is not just about a tap being turned off in one corner of the market. It’s also sparked by fears about what will happen to bigger oil states in the wake of overthrow and disorder in Tunisia, Egypt, Bahrain and Libya. How Saudi Arabia handles pressures for greater democracy is the one to watch: like Communist China, the kingdom has tried to keep its people happy by spreading the wealth (in a way which the one-eyed rulers of Tunisia, Egypt and Libya didn’t).
Gavyn Davies’ conclusion is that a short-term spike in oil prices is something people can live with – if you look back at short-term economic ‘events’ of the past, people usually find a way of muddling through, dipping into savings here, cutting back on spending there. Libya’s oil production is unlikely to be lost permanently, whatever happens to Gaddafi.
Those of you with long memories (or grey hairs) might recall the oil crisis of 1973-74. Then, the decision of the US to keep arming Israel in its conflict with Egypt saw Arab oil producers hit back with an embargo on oil production. Prices rocketed overnight and economic growth fell over. The UK government even went as far as printing and issuing petrol vouchers, though they never came into use.
We are not in that kind of territory, and oil would have to rise far above its current price and stay there for sometime for it to knock the stuffing out of global economic growth.
The immediate challenge for the UK economy is what the Bank of England does about rising inflation, which could well tick up again because of a short-term rise in oil prices.
Does it put up interest rates to try to rein in all this inflation, or leave them where they are as business and consumers struggle in a weak economy with rising prices?
That’s an event to keep an eye on.