Oil Price Increases Impact Economy

Ed: This is an analysis of the energy multiplier from March 2000. A few observations:

• Economic analysis depends on historic data. Oil prices increase direct costs like increased heating and gasoline expenses, indirect costs from higher prices for goods and services, and wage inflation. The cycle takes 3 to 4 years before economists can conclude the cyclical impact. 
• Forecasts can be short sighted. For example, this 2000 study concluded:

  In summary, the reduced utilization of petroleum in the U.S. and Michigan economies in the past 20 years makes us less vulnerable to economic disruptions due to increases in crude oil and petroleum product prices. However, the recent price increases have been significant and, while they are not expected to cause a severe impact on the economy as a whole, the impact on low-income households can be crucial.

• The estimated multiplier is 2x the percentage of household income spent on fuels. 
• When prices increase dramatically, the multiplier may not be linear. Linear forecast is the normal extrapolation from data-constrained economists.
• Slow, inaccurate economic analysis contribute to the Energy Independence problem.

		Oil Price Increases Impact Economy Less Now March 3, 2000 Michigan Public Service Commission Department of Consumer and Industry Services

The sharp increase in crude oil and petroleum product prices since the spring of 1999 have had little impact on the national and Michigan economies. After falling to about $10 a barrel a year ago, crude oil prices reached $30 a barrel in January and February 2000. During the four years of the 1979-1982 recession, the average cost of crude oil was more than $28 a barrel, and the impact of high oil prices had a devastating impact, triggering the worse recession since the Great Depression. Analysis suggests: Economy-wide expenditures for petroleum are currently three to four times smaller than in 1979-1982. Efficiency improvements, switching to other fuels, and much lower inflation-adjusted petroleum prices all contribute to less utilization of petroleum in the U.S. and Michigan economies. The momentum of the economic expansion appears to be sufficiently larger so as to override any impact of the oil price increases seen to date. However, if crude oil prices remain at or above $30 per barrel, there may be some potential for a slowing of the economic expansion. With concerns about economy over-heating, any slowdown might actually be helpful to reduce inflationary pressures. While the impact of rising prices is much smaller on the U.S. and Michigan economies, the impact is significant for low-income households. This is especially true for those Michigan households heating with fuel oil or propane. The U.S. Experience 1979-1983

Prior to the 1970s, the world's petroleum prices were largely controlled by the Texas Railroad Commission. In 1973, the Organization of Petroleum Exporting Countries (OPEC) began to assume a major influence on oil prices. Impacts are clearly seen in Figure 1, which shows crude oil prices from 1967-1998. OPEC, founded in 1960 by five leading oil producers including Saudi Arabia, had previously not attempted to influence oil prices. OPEC had originated to help coordinate its members' petroleum policies and safeguard their interests. In 1970, its members each agreed to set an oil export tax rate of 55 percent. Then, in 1971, OPEC members began to nationalize the oil industry by

negotiating its transfer from the oil companies that had previously negotiated rights to the oil. The Arab-Israeli War in 1973 and the U.S. support of Israel contributed to causing the first significant oil price increase by OPEC. In October 1973, Arab members of OPEC declared an embargo on exports to the U.S. As a result, crude oil prices increased from an average of $4.15 per barrel in 1973 to $9.07 in 1974, and this price increase led to the U.S. recession in 1974. In the late 1970 s, political unrest in the Mid-East created conditions for the dramatic oil price increases of 1979-1981. The government under of the Shah of Iran, supported by the U.S., was the center of turmoil. When anti-west Islamic fundamentalists gained control of the country during the Iranian Revolution, Iranian oil production declined dramatically, leading to huge price increases. U.S. crude oil prices increased from $12.46 per barrel in 1978 to $35.24 in 1981. Once again, oil price increases put the U.S. and other industrial economies into a recession, this time the worst recession since the Great Depression. Inflation skyrocketed, peaking at 13.5 percent in 1980 and averaging 10.3 percent in the 1979-82 period. Recent Oil Price Developments The cost of crude oil for U.S. refiners was just over $20 in 1996. Prices dropped slightly in 1997 and then fell to just $12.04 per barrel in 1998. For the first two months of 1999, the acquisition cost for crude fell again – to $10.50 a barrel. In these years, countries around the world benefitted from the lower costs of virtually all petroleum products. In early 1999, most petroleum analysts viewed oil prices as artificially low, and the resulting low prices cut revenues to oil exporting countries. To address this situation, OPEC met in March 1999 and agreed to cut production, with a goal of increasing crude prices to around or just above $20 per barrel. Although compliance to previous OPEC agreements had been difficult to maintain, adherence to this agreement has generally been good. Crude oil prices rose immediately, to $15 in April and to above $21 per barrel (U.S. refiner cost) by September 1999. OPEC met again in September 1999 and agreed to maintain the production cuts through March 2000. The production cuts combined with persistent world economic growth pushed crude oil prices up, to above $24 in December. In early January 2000, Saudi Arabia indicated OPEC's resolve to stick to the production cuts through March, in spite of declining world crude oil and product inventories. Prices continued up, hitting $30 per barrel in January and again in February 2000, compared to $10.25 one year earlier. Indications from OPEC members in late February now suggest that production will be stepped up when OPEC next meets in March; some indications suggest that production has already started to increase. It is clearly in OPEC's interest to maintain market stability without harming the world's economy. Why the Little Apparent Economic Impact of Recent Oil Price Increases? So far the U.S. and Michigan economies haven't reacted to the recent petroleum price increases. Is the impact yet to come? Perhaps the impact won't occur until the price sticks for a time at some threshold price, maybe $35 or $40 dollars per barrel?

In fact, the key change is that the U.S. and other economies are much less dependent on oil than they were 20 years ago. Two factors account for this change. First, $30 oil this year is much less expensive than $30 oil in 1980 due to inflation. Second, and more significant, the utilization of petroleum in the U.S. economy is much less now; the U.S. simply produces much more national output for each barrel of oil consumed. Figure 2 shows the impact of adjusting crude oil prices for inflation. The inflation-adjusted prices are in 1999 dollars. The figure shows the 1981 year's actual price of $35 adjusts to $60 dollars a barrel in today's dollars. This suggests that, in real terms, oil prices would have to reach $60 per barrel today to match the 1981 price and the resulting impacts. Note too that once adjusted for inflation, today's oil prices are almost as low as those in the late 1960s. Efficiency improvements and the use of other energy sources, such as natural gas and electricity, have also lessened the dependence of the U.S. economy on oil.

Figure 3 shows the improved performance of the U.S. economy based on per barrel of oil consumed. In the 1970s, the economy generated about $250,000 of national output based on per barrel of oil consumed. Now the economy produces over $450,000 per barrel, an 80 percent improvement. Figure 4 shows crude oil expenditures as a percent of Gross Domestic Product (GDP). The graph essentially reflects the combined effects of inflation and the decreased reliance on oil. As the figure shows, the U.S. economy spent more than 6 percent of GDP on crude oil in

1980 and 1981, when crude oil averaged $28 a barrel. In 1996-97, crude oil averaged $20 per barrel, 28 percent less than in 1980-81. However, the percent of GDP spent on crude oil is less than 2 percent and was just 1 percent in 1998, compared to more than 6 percent in 1980-81. This indicates that rising oil prices are less capable now of affecting the economy than they did in 1980. (Crude oil expenditures represent about one-half the retail costs of petroleum products.) Additionally, Figure 4 shows two hypothetical oil price projections for the year 2000, at $20 and $40 per barrel. The $40 per barrel price (not a projection, and set for illustration only) would yield U.S. crude oil expenditures only 3 percent of the GDP. While such an increase might slow the current economic expansion, the impact of $40 oil on the present economy would be less than in any of the 11 years during 1974-1985 and less than one-half the impact of 1980-81. Price Impacts Michigan and the nation are impacted by higher oil prices by direct, indirect, and induced economic multiplier effects. Direct impacts are the increased expenses for purchased oil or oil products. Indirect impacts include the changed prices paid for other products and services, which pass along the higher fuel costs in the product prices. Last are the induced impacts of price increases. The initial direct and indirect impacts cause consumer prices to rise, and this feeds through to wage increases, which raises labor costs, which, in turn, raises the prices of products and services. The U.S. General Accounting Office (GAO) in "The Prospects for Economic Recovery," February 1982, concluded that the increase in oil prices directly and indirectly caused most of the high inflation in the 1979-1981 period. For consumer prices, the GAO looked at the direct increases in expenses for consumers for gasoline, fuel oil, etc. and the indirect costs of higher prices for other goods and services. Figure 4 captures in a simple way the direct and indirect impacts to consumers. This figure shows that crude oil expenses rose from about 4 percent of GDP in 1978 to 6.5 percent in 1981. This 2.5 percent increase passes through to households directly in gasoline and heating fuel costs, and indirectly in higher prices of goods and services, which roll in their higher input (fuel) costs. The total direct and indirect impacts are approximately the full 2.5 percent change in total economy costs resulting from the crude oil price increase. This created another round of price increases. In the 1979-82 period, many wage contracts had automatic price escalators (consumer price indices). Assuming 80 percent of wages and salaries increased to offset the 2.5 percent increase in consumer costs, the total wage bill for the economy would rise 2.0 percent (2.5 x .80), and this would again raise prices for consumers. The impact was repetitious in the 1979-82 period, leading to final consumer price impacts which were more than double the initial 2.5 percent impact. These are the induced impacts of the initial price increase. Today, the induced effects are almost negligible because wage contracts are not typically tied to a price escalator as they were in 1980. Therefore, a petroleum price increase this year would be absorbed into consumer budgets with virtually no (or a very small) step up in labor costs. Breaking the firm link between increasing consumer costs in wage agreements has served to mitigate the economic multiplier impact of price increases.

Michigan Oil Expenditures Trend Figure 5 shows embedded crude oil expenditures for Michigan as a percent of Michigan's Gross State Product (GSP). These expenditures are much less than the actual retail costs of Michigan businesses and households for petroleum products, which also include refining costs, wholesale and retail markups, and taxes. For instance, in Figure 5 the year 1990 falls exactly at 2 percent, representing crude costs

of $3.76 billion. But, the actual Michigan costs for petroleum products in 1990 were $7.2 billion, or 3.86 percent of the GSP. Again, as a rule of thumb, the total retail costs are about double the crude petroleum costs shown on the graph. Michigan consumes less petroleum products per unit of output than the nation, as seen by comparing Figure 5 with Figure 4. In 1981-82, Michigan's petroleum expenditures peaked at less than 5 percent of GSP, compared to more than 6 percent nationally. Michigan's lower reliance on petroleum is due to the wide-spread availability of natural gas in Michigan. Michigan would see less direct impacts of continued high oil prices than the nation, given the relatively lesser amount of petroleum fuel used in Michigan. However, the indirect and induced price impacts would be similar in Michigan as for the U.S. Indirect impacts would be based on the consumption of all goods and services, not just Michigan products. The induced impacts would be similar to national impacts, since wage agreements in Michigan would typically use a national price index rather than a local index. However, as noted above, wage increases are not as closely linked to consumer prices as they were in the past, and this would serve to mitigate the negative economic multiplier impacts on inflation. Michigan Household Impacts Although the aggregate economic impact of changing oil prices has greatly diminished, changes in the prices of petroleum products are significant for Michigan households. The average Michigan household consumes 1,006 gallons of gasoline per year. The abundant natural gas supply and an extensive pipeline network have reduced the number of homes heating with fuel oil since the

mid-1970s. Michigan's household consumption of fuel oil has declined from 800 million gallons annually in the mid-1970s to 165 million gallons currently. Seventy-seven percent of Michigan homes now heat with natural gas. There are 236,300 fuel oil-heated homes and 207,300 propane-heated homes in Michigan, comprising 7 percent and 6 percent of Michigan homes, respectively.

The adjacent graph shows the cost impacts of changing fuel prices for the average Michigan household. The fuel oil and propane costs are for an average home using these fuels, as are the gasoline figures. For the projected year 2000, the graph shows Michigan average household gasoline costs based on the U.S. Department of Energy's Energy Information Administration's national gasoline price projection. This projection shows very little change in gasoline prices for the rest of the year, which is also a reasonable assumption for propane and fuel oil. Since January 1999, Michigan gasoline costs are up more than $400 per household at either current or year 2000 projected prices, as shown on the immediate graph. Fuel oil costs are up over $200 annually and propane costs are $300 higher. Households that heat with either fuel oil or propane

will see fuel cost increases of $600 to $700 a year, compared to last year. On a monthly basis, the impact is greatest in winter months (an increase of approximately $100 a month during the heating season) and does not reflect any changes in bills due to changing weather conditions. Obviously, these additional costs cannot be avoided by most households and are significant for households on tight budgets. Also, the cost increases cut discretionary spending and may contribute to wage inflation pressures.

Longer-term actual and inflation-adjusted fuel prices for Michigan households are shown in the adjacent graphs above. After adjusting for inflation, current prices are still relatively low. Inflation-adjusted prices, shown in 1999 dollars, have been falling since the early 1980s and are not much higher now than before the oil embargo of 1973. Michigan's average gasoline price peaked in real terms in 1979 at $2.92 ($1.27 actual), compared to the current price of $1.50 per gallon (AAA Michigan, February 21, 2000). The real price of heating oil and propane also peaked in 1979 at $2.11 ($1.15 actual) and $1.46 ($0.64 actual) per gallon, respectively. As of February 21, 2000, the average Michigan prices of fuel oil and propane were $1.19 and $1.20, respectively. In summary, the reduced utilization of petroleum in the U.S. and Michigan economies in the past 20 years makes us less vulnerable to economic disruptions due to increases in crude oil and petroleum product prices. However, the recent price increases have been significant and, while they are not expected to cause a severe impact on the economy as a whole, the impact on low-income households can be crucial.

Prepared by the Statistical Analysis Section, Executive Secretary Division, MPSC, March 3, 2000

US Consumes More Gasoline Than 20 Other Countries

A Picture is Worth… Gasoline Consumption Per Day

In light of the Clinton-McCain gas tax holiday proposal I think this statistic (shown after the jump) from the Economist and BP Statistical Review of World Energy 2005 should be highlighted.

The image shows gasoline consumption per day around the world. It shows that the USA is consuming more gasoline than 20 other countries do together, every day.

If there is anyone that should get tax cuts it’s the people who buy small and fuel-efficient vehicles. Or even better, the people who use public transportation instead.

Dashboard of Energy Facts

US Sales of Hybrids Down 6% in July 08 US sales of hybrids were down 6% in July 2008 year-on-year, for a new vehicle market share of 2.4% ofr the month. Global Energy Consumption Up; Coal Fastest Growing Fuel The ongoing strength of world economic growth last year, despite financial market turmoil which began in August, continued to support global energy consumption. Although Growth in primary energy consumption slowed in 2007 compared to 2006, but at 2.4% it was still above the 10-year average for the fifth consecutive year, according to the BP Statistical Review of World Energy. Coal remained the fastest-growing fuel, but oil consumption grew slowly. US VMT Down 1.8% in April; Sixth Straight Month of Declines US vehicle miles traveled (VMT) dropped 1.8% in April, for the six monthly decline in a row. Total estimated VMT for the month was 245.9 billion miles. Moving 12-month total shown. Sales of Cars Pass Trucks Three Months Running Car sales in May exceeded truck sales for the third month in a row, with the gap between the two widening each of those months. New US Hybrids in April Pass 3% Market Share Reported sales of hybrids broke past a 3% share of new vehicle sales in April 2008.

• Energy Flow from DOE

 
Click on image to expand. 

Transportation: 30%; Residential, commercial, industrial with 20%+ share.

• 
  U.S. Energy Consumption by Fuel (1980-2030) 
  (quadrillion Btu)
  


• Interesting Page of Oil Stats

In terms of total US energy usage, the breakdown by source is given in the following table (for late 2001):

Energy Source	Percentage of total
Petroleum	42%
Coal	24%
Natural Gas	20%
Nuclear	8%
Hydro power	2%
Solar, Wind, etc.	2%

GENI Energy Map of the USA, power grid, nuclear plants

Renewable Energy Share - Biofuels, Biomass, Geothermal, Hydro, Solar, Tidal, Wave, Wind

Renewable energy
	Biofuels • Biomass • Geothermal Hydro power • Solar power • Tidal power Wave power • Wind power

Hydroelectricity from Wikipedia

Hydroelectricity

From Wikipedia, the free encyclopedia

Hydroelectricity is a form of hydropower, and is the most widely used form of renewable energy. Once a hydro complex is constructed, the project produces no direct waste, and has a considerably different level of carbon dioxide (CO₂)--a greenhouse gas--output than fossil fuel powered energy plants. Hydroelectricity supplies an estimated 715,000 MWe or 19% of world electricity, (16% in 2003) accounting for over 63% of the total electricity from renewable sources in 2005.^[1]

Although large hydroelectric installations generate most of the world's hydroelectricity, small hydro schemes are particularly popular in China, which has over 50% of world small hydro capacity.^[1]

Some jurisdictions do not consider large hydro projects to be a sustainable energy source due to the human, economic and environmental impacts incurred as a result of dam construction and maintenance. Opposition considers hydropower to be an energy source of sometimes great potential when projects can be environmentally and economically effective, however they believe that that potential is currently being exploited in a way that provides neither democratic nor viable alternatives to energy needs.^[2]

Renewable energy sources worldwide at the end of 2006. Source: REN21^[3]

UK: What's New from BERR

31 July 2008: Digest of UK Energy Statistics 2008

The Digest of United Kingdom Energy Statistics 2008 is published today (Thursday 31 July) by the Department for Business, Enterprise and Regulatory Reform. Included with the Digest this year is the popular booklet “UK Energy in Brief, and the Energy Flow Chart.

Data for 2007 in Energy Consumption in the United Kingdom are also released on 31 July, on the internet. This publication brings together statistics from a variety of sources, providing a comprehensive review of energy consumption in the UK since the 1970s.

In addition, UK Energy Sector Indicators are also released on 31 July.

• Digest of UK Statistics 2008: press release 
• Digest of United Kingdom energy statistics 2008 webpage
• UK Energy in Brief: 2008 webpage
• Energy Flow Chart webpage
• Energy consumption in the United Kingdom webpage
• UK energy sector indicators 2008 webpage

24 July 2008: Severn tidal power feasibility study: List of proposals published

A list of 10 proposed projects that could provide clean, green energy from the tide in the Severn Estuary is being considered. The list has been published at an event to discuss the progress of the feasibility study in Cardiff attended by organisations such as environmental groups, local businesses and councils.

• Severn tidal power feasibility study: press release
• Tidal power: Severn Estuary webpage

23 July 2008: National Nuclear Lab given green-light

Business Secretary John Hutton today confirmed the Government will establish a National Nuclear Laboratory, and launch a competition to appoint a commercial operator to run the organisation.

• National Nuclear Laboratory: press release

22 July 2008: Draft criteria and process for siting potential new nuclear power stations published

The detailed criteria and process for assessing where new nuclear power stations could safely and securely be built across England and Wales have been set out by the Government today.

The consultation on the Strategic Siting Assessment outlines the process the Government will use for identifying suitable sites for new nuclear power stations. The Government is proposing to invite third parties to nominate sites which it will then assess against a range of criteria.

• Strategic Siting Assessment: press release
• White Paper on Nuclear Power 2008: Open Consultations webpage

21 July 2008: North East set to be manufacturing hub for offshore wind

Expansion in offshore wind could create up to 30,000 new jobs in manufacturing and bring £3 billion of investment to the North East, Energy Minister Malcolm Wicks will say during a visit to Gateshead and Northumberland.

• Offshore wind expansion in North East: press release

17 July 2008: Report highlights energy progress

BERR publishes the fifth annual report on progress towards the goals of the 2003 Energy White Paper today.

Energy Minister Malcolm Wicks said: "In the 2003 White Paper, we identified energy security and climate change as two of our key policy challenges. Five years on, these issues have emerged as among the foremost challenges of the 21st century for governments around the world.

"The goals set out in the 2003 White Paper are still entirely valid, and this annual report sets out our progress against them. Five years on, of course, we have also built on those goals, not least through the 2007 Energy White Paper, and in many areas we are going further and faster."

The full goals were (and remain): reducing carbon emissions, ensuring reliability of supply, maintaining competitive markets and combating fuel poverty.

• Energy White Paper 2003: Annual Reports webpage

UK: What's New from BERR, Green Blueprint, Stats, Renewables Advisory Board, Lincolnshire Biomass Station

30 June 2008: Next steps on carbon capture readiness and UK demonstration competition

The four bidders that have pre-qualified in the Government's carbon capture and storage (CCS) demonstration competition were named by Business Secretary John Hutton today. He also announced publication of a consultation on the legislative framework for CCS, including carbon capture readiness.

• Carbon Capture and Storage demonstration competition/consultation: press release
• Carbon Capture and Storage (CCS) webpage

26 June 2008: Tenfold renewables increase to propel UK toward low carbon future

Green energy blueprint to create 160,000 jobs

A national renewable energy blueprint designed to slash carbon emissions dramatically, reduce the UK's dependency on oil and gas and claim a valuable share of global green business opportunity was set out by Business Secretary John Hutton today.

• Renewable Energy Strategy consultation: press release
• Renewable Energy Strategy consultation webpage

26 June 2008: Energy Statistics

Energy Trends and Quarterly Energy Prices publications are published today 26 June by the Department for Business, Enterprise & Regulatory Reform. Energy Trends covers statistics on energy production and consumption, in total and by fuel, and provides an analysis of the year on year changes. The June edition of Energy Trends also includes articles on: "Renewable energy in 2007", and "Regional and local use of road transport fuels 2006". Quarterly Energy Prices covers prices to domestic and industrial consumers, prices of oil products and comparisons of international fuel prices.

• Energy statistics: press release
• Energy Trends webpage
• Quarterly Energy Prices webpage

18 June 2008: RAB says UK's proposed renewable energy target is achievable

The Renewables Advisory Board has reported that the UK could generate 14% of its total energy from renewables by 2020 if a set of identified radical policy changes are put into effect quickly. Recommendations include accelerating grid studies, streamlined consenting processes, early introduction of revised support mechanisms and, most importantly, strong political leadership.

• Renewable energy target: press release
• Renewables Advisory Board website
• BERR: Renewables Advisory Board webpage

16 June: 2008: Biomass power station to be built in Lincolnshire

The Energy Minister, Malcolm Wicks, has today given the go ahead to Helius Energy plc to construct a 65 MW biomass power station near Stallingborough in North East Lincolnshire.

• Stallingborough power station go ahead: press release

13 June 2008: Wind power takes off with new agreement on radar and aviation

A landmark agreement has been reached between Government and industry which aims to remove aviation and radar barriers to the major expansion of wind energy that has been outlined by Business Secretary John Hutton.

• Wind power agreement on radar and aviation: press release

12 June 2008: Hutton tells global nuclear investors to build in Britain

The UK is a leader in a new global nuclear investment 'league table' and looks set to attract the world's leading energy companies to build its next generation of nuclear power stations, research commissioned by Business Secretary John Hutton has found.

• Global nuclear investors: press release

UK: What's New from BERR, Nuclear, microgen, stats

31 March 2008: Next step taken towards new nuclear power with start of justification process

The nuclear industry has been invited today to bring forward new reactor designs for a Justification Decision, an important stage in getting the first new nuclear build started in the UK.

• Nuclear Justification process: press release
• Justification of New Nuclear Power Stations webpage

31 March 2008: April overhaul for microgen grant scheme & planning rules

An overhaul of the Government's Low Carbon Building Programme (LCBP) will see more generous grants for schools and public buildings, while the £10 million support still available to householders will be extended until 2010 for new applications.

• Overhaul of Low Carbon Building Programme (LCBP): press release
• Low Carbon Building Programme (LCBP) webpage

27 March 2008: Energy Statistics

Energy Trends and Quarterly Energy Prices publications are published today by the Department for Business, Enterprise and Regulatory Reform. Energy Trends covers statistics on energy production and consumption, in total and by fuel, and provides an analysis of the year on year changes. Quarterly Energy Prices covers prices to domestic and industrial consumers, prices of oil products and comparisons of international fuel prices.

• Energy statistics: press release
• Energy Trends webpage
• Quarterly Energy Prices webpage

27 March 2008: Fuel Poverty Advisory Group Annual Report

The Fuel Poverty Advisory Group (FPAG) today published its Annual Report for 2007. In it, FPAG welcomes the Government’s recent announcements in the Budget about the expansion of the energy suppliers’ social programmes and about prices for prepayment customers.

• Fuel Poverty Advisory Group (for England): sixth annual report 2007  (187KB)
• Fuel Poverty Advisory Group press notice: sixth annual report  (19KB)
• Fuel Poverty webpages

25 March 2008: Bevin Boys to be awarded Badge of Honour by Prime Minister

The Prime Minister will today award the first Bevin Boy Badges to a group of 27 Bevin Boys, invited to Downing Street for a special presentation ceremony.

• Bevin Boys badge of honour: press release
• Bevin Boys webpage

6 March 2008: New nuclear programme - Hutton welcomes next steps for NDA sites

Plans for sites owned by the Nuclear Decommissioning Authority (NDA) to be made available to developers were welcomed today by Business Secretary John Hutton.

• Nuclear Decommissioning Authority sites: press release

The Price of Petrol and the China Effect–Causes and Consequences

Ed: Blame shift to China.

Melbourne City Research The Price of Petrol and the China Effect– Causes and Consequences 2006     www.melbourne.vic.gov.au

 

Contents

 

1.           Executive Summary  3

2.           Synopsis  4

3.           The recent record and past trends  4

4.           Causes  6

5.           Economic Impact - Macroeconomic  9

6.           Economic Impact - Consumption  11

7           Australia: Short Term Effects  11

8.           Australia: Long Term Effects  12

9.           Implication for Victoria and the City of Melbourne  15

10.         Summary and Conclusions  16

 

 

 

 

Acknowledgements

This research report was written by George Konstantinidis, Team Leader, Melbourne City Research.

 

Disclaimer

 

The views expressed in this paper are those of the author and do not necessarily reflect the views of the City of Melbourne. All due care has been taken to ensure the content of this report is current and accurate. No legal responsibility is accepted for the information, opinions nor any errors or omissions it may contain.

 

1.           Executive Summary

While petrol prices have risen steeply over the past two years, in real terms they are still below the record levels reached in 1980 and represent a lower proportion of average weekly earnings now than they did in that year. Together with a substantial reduction in the energy intensity of production, this explains why the current oil price hike has not had the negative impacts on inflation and economic growth associated with previous experience.

However, the size and speed of recent price increases are substantial and, unlike previous rapid increases, are primarily demand driven. The key drivers are associated with record growth rates in the world economy and more particularly the rapid industrialisation of the Chinese economy.

Coupled with declining rates of new discoveries, reduced capacity and rising international tensions, the longer term outlook is for an upward pressure on oil prices over the next few years, with projected demand growth (especially from China) running up against long term supply constraints.

The short term effects for Australia appear to be some reduction in petrol purchases, as well a small negative impact on retail spending and discretionary expenditures, particularly by lower income households. Australia is expected to be least affected however, as it has a relatively high level of oil self-sufficiency and is a net energy exporter.

Of far greater significance to the Australian economy is the wider context in which current rises in oil prices must be seen, namely the major global shift in the relative prices of resource materials and manufactured products - the so-called “China Effect”. As a major exporter of energy and other mining resources, Australia has already experienced, and will continue to experience, a significant turn-around in its terms of trade, together with the consequent appreciation of the dollar and significant improvements in our international ranking of living standards.

The downside of this realignment is significant current and future pressure on Australia’s manufacturing sector and the likelihood that the negative impacts of this pressure will be felt disproportionately by the State of Victoria.

Given the significance of manufacturing in this State as a major employer and the high multiplier effects of manufacturing, any significant deterioration of the State’s manufacturing sector is likely to have significant repercussions for other parts of the economy, including the City’s significant finance, property and business services sectors, as well as City retailing.

It is recommended that these issues be addressed as soon as possible by more specialised research and analysis.

2.           Synopsis

After documenting the extent of recent petroleum price increases, this paper discusses the reasons behind these increases and their economic consequences. In the case of Australia, it is argued that the discussion needs to focus on the wider global restructuring associated with the emergence of China as a manufacturing industry powerhouse and the associated rapid increases in global demand for energy products and other raw materials. The Australian economy as a whole stands as a major beneficiary of this major global shift; at the same time, this presents major challenges to Australia’s manufacturing industry. Given the predominance of manufacturing in the Victorian economy, this State is likely to feel the downside rather than the benefits of this phase of globalisation. It is recommended that the likely impact on the City’s substantial finance, property, business services and retail sectors be the subject of further specialized research and analysis.

3.           The recent record and past trends

In the past two years Melbourne petrol prices have increased by 39%, from 93.9 to 130.5 cents a litre. The rise has been most dramatic in the past 12 months, from 108.1 to 130.5 cents, or 21%. The story is fairly similar in the US, where, with the price of crude oil touching US$75, petrol prices exceeded $3 a gallon for the first time and drivers now pay 14% more than a year ago

Chart 1

SOURCE: FuelTrac PtyLtd

Dramatic as this may seem, the first thing to note is that increases of this scale are not unprecedented. In the two years to April 2001 petrol prices in Melbourne increased by 35%, and in the 12 months to April 2001 by 18%, from 79.7 to 94.1 cents a litre.

Chart 2

SOURCE: FuelTrac PtyLtd

A further perspective is added when fuel prices are considered in the context of CPI and other price movements over a longer period. The following table compares Australian retail petrol prices since 1980 to CPI movements and the price of a number of other products. From this data it emerges in particular that the growth in average weekly earnings over the period has outstripped petrol price increases by 23%. Put another way, back in 1980, putting 50 litres of petrol into a car would have taken up 7.4% of average weekly wages in Australia, whereas today it takes up only 6.3%. In the US case, real retail petrol prices are 20% below the records reached in 1981.

Table 1: Oil prices compared to other prices
	Jan-80	Apr-06		% change		% change in $1980
World oil price, $US/barrel	$US40	$US70		75%		23%
World oil price, $A/barrel	$36	$95		164%		50%
Litre of petrol	$0.33	$1.29		291%		88%
CPI	100	330
Litre of milk	$0.53	$1.95		271%		82%
Holden Commodore	$7,903	$32,990		317%		96%
Average weekly wage	$224	$1,026		359%		109%
Avg Aust house prices	$48,259	$402,181		733%		223%
All Ords share index	$586	$5,200		787%		239%
Source: Thomson Financial, IMF, AMP Capital Investors (http://www.propertyreview.com.au/index.php?id=528)

 

However, the obvious objection to this analysis is that 1980 is a high base: Following the Iranian revolution of 1979 and the commencement of the Iran/Iraq war in 1980, oil reached its all time high of around US$90 a barrel in today’s prices. Nevertheless the above perspective is useful in explaining some of the reasons why the consumer reaction to the current price spike has been a lot more muted than in the past.

Chart 3

 

Source: Saul Eslake ‘The rising price of oil and its economic consequences’ ANZ Bank (http://www.anz.com/business/info_centre/economic_commentary/OilPricesNov2005.pdf)

4.           Causes

While it is true that current prices are well below the 1980 peak in real terms, it is nevertheless obvious from Chart 3 that both the size and the speed of recent increases have been quite unprecedented, and many commentators consider it unlikely that the price of crude oil will return anywhere near the post-war average of around US$23 a barrel.

Chart 4

 

Source: Oil Price History and Analysis , WTRG Economics, in Guardian Unlimited

(http://www.guardian.co.uk/graphic/0,5812,893505,00.html)

The two previous periods of rapid increases in oil prices were both associated with significant reductions in oil supply - the 1973 Arab oil embargo and the 1979/1980 reductions in production by Iran and Iraq following the Iranian Revolution and the onset of the Iran/Iraq war. Unlike these “supply-shock-induced” events, the current price spike is regarded as primarily driven by rapidly rising demand, not a supply shock. Global oil consumption in 2005 stood at 84 mbpd (million barrels per day), 20% higher than the 1995 level of 70 mbpd. Just in the two years to 2004, global demand rose by 4.3 mbpd.(“Oil Market Developments and Macroeconomic Implications”, Reserve Bank of Australia Bulletin, October 2004).

These significant demand side pressures are associated with growth in the world economy at around the highest rates in nearly 30 years, with much of this increased demand coming from China and the US. Over the past four years, China has accounted for 38% of the growth in global demand. An announcement by Chinese President Hu Jintao that his country's economy grew in the first quarter of 2006 at a rate of 10.2% also contributed to the price increase and suggests further rapid rises in Chinese demand for imported oil products.

 

Chart 5

 

Source: Saul Eslake The rising price of oil and its economic consequences ANZ Bank (http://www.anz.com/business/info_centre/economic_commentary/OilPricesNov2005.pdf)

Indeed, current IMF projections are for global oil demand to continue growing strongly to some 140 mbpd by 2030.

Chart 6

 

Source: Thomson Financial, IMF, AMP Capital Investors (http://www.propertyreview.com.au/index.php?id=528)

On the supply side, the current situation is summed up by The Guardian as:

"there is practically zero spare oil production capacity available to cover large supply outages" (‘Oil price blame game misses point’ Tuesday April 25, 2006).

The seeds of the current crisis were sown in 1997, when an OPEC decision to lift production quotas was taken shortly before the Asian currency crisis, which undermined demand from the region that was expected to be the greatest source of new demand. Oil soon fell to $10 a barrel, and in the last quarter of 1998 post-tax profits for the six biggest American producers fell 90%.

This, in turn, led to the slashing of investment in exploration, production and refinery capacity, and the subsequent China-Asia demand boom was met not so much by increased production but by reductions in excess capacity - from around 6 mbpd in 2002 to less that 1 mbpd in 2006.

Historically, OPEC has had significant excess capacity and has used this capacity to reduce swings in prices by adjusting supply. Now, however, OPEC’s excess capacity has shrunk to its lowest level for several decades and represents less than 1% of current demand. Only Saudi Arabia claims to have some spare capacity remaining.

This, in turn, makes the world much more vulnerable: if disaster (eg Katrina), war or terrorism disrupts production in one location, it will be much harder to make up the loss with increased production elsewhere.

Chart 7

     

Coupled with increased demand and reduced capacity, international tensions (including the Iraq war, the nuclear standoff with Iran, politically inspired disruptions to supply in Nigeria, and oil industry nationalisation threats in Venezuela and Bolivia) are adding to the sense of insecurity and potential vulnerability, with consequent hikes in the price of oil futures:

“With big producers like Nigeria, Venezuela and Iraq looking unstable, people selling contracts to deliver oil in the future are demanding a hefty premium to cover the risk that the contract may mature in the middle of a shortage.” (The Economist, 6 April 2005)

This combination of rapidly rising demand, past underinvestment and current political strife should see continuing high prices for the remainder of 2006 and into 2007:

“World crude oil prices are expected to stay high through 2007 because of strong petroleum demand, limited surplus oil production and refining capacity and concerns about supply disruptions due to geopolitical risks in countries like Iran” (US Energy Information Administration 3 May 2006).

While oil companies and energy agencies continue to maintain the traditional textbook paradigm that rising oil prices will themselves restore supply/demand equilibrium by providing the incentive for increased investment in exploration, extraction and refinery capacity, an increasing body of evidence suggests that there are significant constraints to increased supply, and that petroleum supplies may well peak in the next decade.

While allowing that higher prices provide an incentive for increased spending on exploration, development and research into alternative energy sources, proponents of this view point to the lack of any large discoveries since 1980 - the discovery of new oil reserves is currently running around 10 billion barrels per annum compared to 40-50 billion in the late 1950s/early 1960s. Coupled with soaring demand, the world economy is now consuming more than four barrels of oil for every new one discovered:

“Total new discoveries have been steadily declining for 40 years, and world consumption has outpaced newfound reserves for nearly a quarter of a century. The global economy today now uses more than four barrels of oil for every new one discovered….More and more of the legacy of past discoveries is being consumed. In 1975, about 65% of total discoveries were in production. Through the end of 2003 that figure had risen to 85% of all the oil ever discovered.” (Marshall Auerback, Asia Times, 4 May 2005, www.atimes.com/atimes/Global_Economy/GE04Dj03.html).

Overall, then, current prices appear to reflect a combination of medium to long term demand and supply factors. The longer term outlook is for an upward pressure on oil prices (at or above US$100 over the next few years), with long-run growth in demand - especially from China - running up against long term supply constraints.

5.    Economic Impact - Macroeconomic

The sharp increases in oil prices in the 1970s had significant ‘stagflationary’ effects on the world economy, with lower economic growth accompanying upward pressure on inflation. The cost-push effects on output were further accentuated by central banks adopting contractionary policies to stem inflationary pressures.

The ‘rules of thumb’ based on previous oil shocks suggest that sustained increases in the price of oil will have a significant detrimental impact on output and inflation. The IMF, for example, estimates that a US$10 increase in the price of oil subtracts 0.6 percentage points from output and adds around 0.4 percentage points to inflation in industrialised countries:

Table 2

Source: Saul Eslake ‘The rising price of oil and its economic consequences’ ANZ Bank, adapted from

IMF, The Impact of Higher Oil Prices on the Global Economy(Washington DC: 2000).

 (http://www.anz.com/business/info_centre/economic_commentary/OilPricesNov2005.pdf)

What has come as a surprise to many commentators is that the current round of price increases has not had any apparent effect on global output, with the IMF predicting another year of GDP growth of nearly 5% and noting with some surprise that the soaring oil prices of the past 18 months have had little effect on oil-importing economies (Economist online, 19 April 2006).

There are several reasons for suggesting that the implications of the most recent rise in oil prices will be less serious than was the case in the past:

§      As noted at the beginning of this paper, the current level of oil prices is lower, in real terms, than the prices reached in the late 1970s.

§      The latest price rises have not been as rapid as the earlier episodes.

§      The energy intensity of aggregate world output is markedly lower than it was in the 1970s: In 1980 America used a little over 17mbpd to produce GDP worth 45.2 trillion (in 2000 $). By 2005 oil consumption reached 20.7 mbpd, but GDP had more than doubled to $11.1 trillion. Although in the case of the US and other OECD countries this has to some extent been due to the higher share in total output of the less energy-intensive services sector, a similar trend is observed in newly industrialised countries as well, and the global oil intensity of production has declined over the past 35 years from nearly 4mbpd to around 2mbpd per US$1000 of real GDP (see Chart 8).

§      Unlike the 1970s, current price rises are occurring in a macroeconomic environment in which inflationary expectations are anchored at low levels, with much lower risks of second-round 1970s-style inflationary consequences.

§      Perhaps most importantly, current price rises are demand driven by the highest rates of global economic growth in nearly 30 years, as opposed to the 1970s supply-side shocks with entirely unfavourable consequences for output.

§      Lastly, the impact of rising oil prices due to demand pressures associated with economic growth in very fast-growing economies such as China, India, Brazil and Pakistan has, as an anti-inflationary corollary, the production and trade of much cheaper manufactured products. - while pushing up the price of commodities, China is at the same time pushing down the price of finished goods, a process recently referred to by the Commonwealth Bank as “The China Effect” (Joseph Capurso “China rewrites the inflation equation”, Commonwealth Research Economic Issues, 13 March 2006). Putting the same point in a slightly different context, the competitive pressures created by globalised production and trade are imposing themselves on local manufacturers by reducing their ability to pass on rising costs in the form of higher prices.

Chart 8

Source: Saul Eslake ‘The rising price of oil and its economic consequences’ ANZ Bank (http://www.anz.com/business/info_centre/economic_commentary/OilPricesNov2005.pdf)

 

 

 

 

 

 

6.    Economic Impact - Consumption

As noted above, economies have become a lot more fuel-efficient in recent years and, consequently, spending on petroleum products is a smaller percentage of income. On the other hand, governments have also begun taxing fuel more heavily, so the price of petrol has generally increased faster than the price of crude oil. On balance, however, since the 1970s retail petrol prices have risen at a lower rate than disposable income:

In 1970 Americans spent 3.4% of their consumer dollars on petrol and oil. By 1980 it rose to 5%. Yet in 2005, after a year of steadily rising oil prices, that number was 3.3% Consumers are grumbling, however, because they remember happy days, as in 2002, when households spent a scant 2.2% of their income on fuel. (‘Calculating the costs of pricey oil’ Economist, 28 April 2006).

Still, there is evidence that the steepness of the recent oil price spike is affecting consumer behaviour, and some analysts are suggesting that Americans were showing signs of slightly adjusting their driving habits to ease the sting of near-record retail gasoline prices, using smaller cars and cutting back on discretionary road trips.

7     Australia: Short Term Effects

Applying the IMF ‘rules of thumb’ (see Table 2 above) to the Australian case we can anticipate that a US$10 in per-barrel crude oil prices would imply a reduction in Australia’s employment and GDP growth, a contribution to inflation, and a deterioration in the terms of trade from what would have otherwise been the case. This approach has been adopted by a number of commentators including:

§      NIEIR in their Energy Working Party Report Q3 2004 (http://www.nieir.com.au/code/research_centre/reports/energy/Oil_Shock.pdf)

§      the Reserve Bank (‘Oil Market Developments and Macroeconomic Implications’, Reserve Bank of Australia Bulletin, October 2004),

§      the ANZ Bank (‘The impact of oil on the Australian economy’, Economic Update, 1 Sept 2004), and

§      the Commonwealth Bank (eg ‘How dangerous are high petrol prices?’, Economic Issues, 12 Sep 2005)

Data from the 2003-04 ABS Household Expenditure Survey (HES) shows that in that year Australian households spent on average $32.28 per week on automotive fuel, or 3.5% of disposable income. Assuming no change in average consumption, the ANZ Bank estimates that this amount would have increased by 31% to $42.5 per week (or 4.3% of disposable income) in the September quarter 2005.

This 3.5% average in the HES varied across the income range, with the poorest 20% of households spending 5.5% of their income on automotive fuel, and the richest 20% spending only 2.5%. In turn, low income households direct a much larger share of their income towards retail expenditures.

Consequently, rising fuel prices are affecting lower income households the most, as well as having a disproportionate impact on retail spending and discretionary expenditures such as travel, entertainment and recreation. A recent survey by Sensis (reported in the 24 April 2006 issue of the Commonwealth Bank’s on-line publication Economic Issues) reports that about one-third of respondents have cut spending because of high petrol prices, with expenditure on entertainment/recreation bearing the brunt, together with some evidence of a muted shift to alternative transport modes such as rail and bus.

There is emerging evidence that consumers have also reacted to the price increases by reducing petrol purchases the Commonwealth Bank (Economic Issues, 24 April 2006) has reported an 8% decline in the volume of petrol spending during 2005, the largest annual decline in the 20 years for which data is available.

Overall, the ANZ Bank estimates that a sustained rise of 10% in the price of petrol would cut real consumer spending by 0.3%, leading to a 0.2% cut in GDP growth as a first round effect. With petroleum and coal inputs accounting for around 1.2% of intermediate inputs (excluding wages) and automotive fuel comprising 4.25% of the CPI, the direct impact on inflation is estimated at 0.4%, although indirect effects could potentially be half of that again. Finally, the effect on the trade balance is estimated as a deterioration of the current account deficit of around 0.1% of GDP, leading to a combined effect on GDP growth of -0.3%. (‘The impact of oil on the Australian economy’, ANZ Bank Economic Update 1 Sep 2004).

8.    Australia: Long Term Effects

Estimates of the short-term effects of oil price rises on the Australian economy such as those just discussed have one major shortcoming: they treat oil price increases in isolation from the wider context in which they are occurring, namely rising demand for energy and other raw materials from the emerging economic powerhouse of China.

As put by ANZ Bank economist Saul Eslake, in assessing the impact of the current round of rising oil prices on the Australian economy it is crucial to bear in mind that the rise in oil prices is just one aspect of a major global shift in relative prices between raw materials and manufactures, which is just one of the consequences of China’s rapid growth and industrialisation, and from which Australia (to a much greater extent than other countries) stands to benefit a great deal.

The following points are highly pertinent in assessing the impact of rising oil prices on the Australian economy:

§      Australia has a relatively high level of oil self-sufficiency, producing 78% of its oil consumption in 2003.

§      Australia is a net energy exporter: its combined Petroleum, Gas and Coal exports in 2003-04 stood at $20.4 billion, compared to imports of $10.2 billion.

§      Along with the rest of the world, the oil intensity of Australian economic activity has declined dramatically in the last 25 years

Chart 9

Source: Saul Eslake ‘The rising price of oil and its economic consequences’ ANZ Bank (http://www.anz.com/business/info_centre/economic_commentary/OilPricesNov2005.pdf)

While Australia is a small net importer of oil, it is a substantial and growing exporter of natural gas and coal, the price of which tends to rise with oil. As a net energy exporter, the overall effect of higher energy prices is to improve Australia’s terms of trade, representing a net transfer of income from overseas .(‘Oil Market Developments and Macroeconomic Implications’, Reserve Bank of Australia Bulletin, October 2004).

Table 3: Australia’s Trade in Energy Resources

2003/04, $ billion

	Exports	Imports
Petroleum	6.6	10.0
Gas	2.8	0.2
Coal	11.0	0.0

Source: ABS Cat No 5368

Furthermore, the key factor responsible for rising oil prices, i.e. rapidly growing demand, particularly from China, has further boosted Australia’s terms of trade through increased demand (and prices) for the rest of Australia’s substantial mineral exports, in combination with the reductions in the cost of manufactured imports discussed earlier. The dramatic turnaround in Australia’s terms of trade since the late 1990s is illustrated in the following chart.

Chart 10

Source: Saul Eslake The rising price of oil and its economic consequences ANZ Bank (http://www.anz.com/business/info_centre/economic_commentary/RisingPriceofOilAug2005.pdf)

 

The wider impact of the ‘China Effect’ on the Australian economy has been succinctly presented by Commonwealth Bank economist Joseph Capurso in the 13 March 2006 issue of Economic Issues

(‘Where is the inflation? China rewrites the inflation equation’ https://www.research.comsec.com.au/ResearchFiles/M/Manufacturing%20MM2.pdf).

The argument, summarised in Chart 11, basically states that a permanent 1% decline in the world price of manufacturing leads to an appreciation of Australia’s currency, a decrease in import prices, an increase in real incomes, and an increase in consumer spending, business investment and, finally, a 2% increase in real gross domestic incomes.

Higher investment, resulting both from stronger consumer demand as well as cheaper physical capital costs, is predicted in all industry sectors except manufacturing. Australian manufacturing represents the downside of this process, with a 5% decline in production after five years.

 

Chart 11

 

The plausibility of these model estimates are borne out in a recent report on trends and prospects for Australian manufacturing (Manufacturing Futures: Achieving Global Fitness, Australian Industry Group, April 2006). Imports as a percentage of manufacturing sales have increased from 27% in 1995 to 44% in 2005, while the latest official data shows company profits before income tax in the manufacturing sector grew by just 1.7% in the year to June 2005, compared 13.2% in the remainder of the economy. If the highly profitable food/beverages sector is excluded, manufacturing profits actually fell by 8.8% over 2004-05.

A key response by the industry has been a rapid acceleration of offshore activity, consisting both of production of final goods overseas and the use of imported materials or components in domestic production. Chart 12 shows that over the next three years the percentage of offshore production is expected to rise from 15% to 25%, involving the loss of an estimated 30,000 jobs.

Chart 12: Percentage of activity derived from offshore production

9.    Implication for Victoria and the City of Melbourne

The positive overall implications of the China Effect scenario are unlikely to apply to Victoria, as the downside with respect to manufacturing is likely to have disproportionate effects on this State. In 2003 Victoria accounted for 34% of Australia’s 1,150,000 manufacturing jobs (compared to its share of around 25% of total employment), while in the most vulnerable sector of Textiles Clothing and Footwear the State’s share stood at 52% (ABS Manufacturing Industry Australia, 8221.0; Labour Force Australia, 6203.0; Labour Force Victoria,.6202.2). Manufacturing represents 16% of total production and 15% of total employment in this State, compared to a national average of 13% and 12% respectively (ABS Australian National Accounts: State Accounts 5220.0). It is not unlikely, therefore, that this State may experience a relative, and perhaps an absolute, deterioration in its national economic position.

Releasing the Manufacturing Futures report, Australian Industry Group chief executive Heather Ridout warned that, on current trends, more than 300,000 jobs would be lost over the next decade, including 100,000 in Victoria (reported in The Age.7 May 2006).

The manufacturing sector is no longer a significant employer in the City of Melbourne itself. According to Council’s 2004 Census of Land Use and Employment (CLUE), manufacturing employed 14,644 persons in the municipality, or 4.5% of the City’s 328,000-strong workforce. Two years earlier, manufacturing employed 15,440 persons, or 4.8% of the total workforce. Longer term trends for the municipality are not available, but they are available for the CBD. In 1982, manufacturing employed 5,631 persons in the CBD, or 3.9% of the CBD’s workforce. By 2004, manufacturing employment had declined to 1,743 jobs, or 1% of the total.

This having been said, it would be misleading to suggest that the City’s economy would be unaffected by any major shake-out of the manufacturing sector. While the municipal economy has undergone virtual de-industrialisation over the past 25 years, the City’s substantial finance and business services sectors has been historically associated with the State’s concentration of manufacturing activity - any significant deterioration of the State’s manufacturing industry base is likely to have significant negative multiplier effects on the City’s finance, property and business services sectors. Furthermore, to the extent that the overall long term effects on the State are on the negative side, there will also be adverse repercussions on the City’s substantial retail sector.

Estimating the likelihood, severity and longevity of any such impacts on the City is outside the scope of this paper. As the matters raised here are of vital significance to the City and its major constituents, it is recommended that further research and analysis be undertaken to quantify the likelihood and extent of the problem and propose options for future action.

10.  Summary and Conclusions

While petrol prices have risen steeply over the past two years, in real terms they are still below the record levels reached in 1980 and represent a lower proportion of average weekly earnings now than they did in that year. Together with a substantial reduction in the energy intensity of production, this explains why the current oil price hike has not had the negative impacts on inflation and economic growth associated with previous experience.

However, the size and speed of recent price increases are substantial and, unlike previous rapid increases, are primarily demand driven. The key drivers are associated with record growth rates in the world economy and more particularly the rapid industrialisation of the Chinese economy.

Coupled with declining rates of new discoveries, reduced capacity and rising international tensions, the longer term outlook is for an upward pressure on oil prices over the next few years, with projected demand growth (especially from China) running up against long term supply constraints.

The short term effects for Australia appear to be some reduction in petrol purchases, as well a small negative impact on retail spending and discretionary expenditures, particularly by lower income households. Australia is expected to be least affected however, as it has a relatively high level of oil self-sufficiency and is a net energy exporter.

Of far greater significance to the Australian economy is the wider context in which current rises in oil prices must be seen, namely the major global shift in the relative prices of resource materials and manufactured products - the so-called “China Effect”. As a major exporter of energy and other mining resources, Australia has already experienced, and will continue to experience, a significant turn-around in its terms of trade, together with the consequent appreciation of the dollar and significant improvements in our international ranking of living standards.

The downside of this realignment is significant current and future pressure on Australia’s manufacturing sector and the likelihood that the negative impacts of this pressure will be felt disproportionately by the State of Victoria.

Given the significance of manufacturing in this State as a major employer and the high multiplier effects of manufacturing, any significant deterioration of the State’s manufacturing sector is likely to have significant repercussions for other parts of the economy, including the City’s significant finance, property and business services sectors, as well as City retailing.

It is recommended that these issues be addressed as soon as possible by more specialised research and analysis.