Demand Destruction? Don’t make me laugh

The Western economies remain in the doldrums. Yet oil prices just surged above $70 a barrel.

Back in mid-March, oil for immediate delivery was $45, while crude to be delivered in 2012 was up at $62. Today, that same futures curve registers prices stretching from $72 at “the front end”, all the way up to $88 in three years’ time.

Since March, then, the entire oil futures curve has shifted decisively upward. But during that period the International Monetary Fund downgraded its global growth forecasts – suggesting the world will use less crude over the next few years.

That should mean lower prices. But crude is now a shocking 120pc dearer than in mid-February – and shows no sign of weakening soon.

Oil prices matter – a lot. So far in 2009, crude has averaged $52 a barrel, compared to $94 last year. That’s yielded a windfall for the world’s oil-importers, not least the major Western economies, of over $1,600bn (£1,000bn) - more than the heralded fiscal stimulus packages announced by the UK, US and Eurozone for this year and next.

This recent oil price rise should cause the Western powers to reflect seriously on their place in the world. For months, mainstream analysts have insisted oil markets were dominated by “demand destruction”.

This was a “comfort-blanket” argument – suggesting oil would stay “fundamentally low” as long as the West remained in a slump. That alternative – an on-going Western recession and high oil prices – was too grizzly to contemplate. But that’s what we now face.

The “demand destruction” argument was always overdone. Across the Western world, oil demand is relatively “income inelastic”, seeing as people want to get around, heat their homes in winter and keep cool in summer whether the economy is slowing or not. So Western oil use hasn’t fallen that much.

But the main reason “demand destruction” is nonsense is that the populous emerging markets have, for the most part, continued to grow despite the credit-crunch. And, as more and more of their people get richer - buying cars, air-conditioners and white goods for the first time - per capita oil use in these nations is growing faster still.

The latest edition of the excellent BP Statistical Review of World Energy, published last week, shows that, for the first time, total oil demand in the emerging markets now outstrips the West. That’s an important milestone. From now on, the Western world can slump but global oil prices can stay “fundamentally” strong.

From less then 10pc just a decade ago, Brazil, Russia, India and China now account for over 20pc of global GDP – the same share as the US, the world’s largest crude importer. Over the next few years, the BRICs’ share of global commerce, along with that of all the other emerging markets, continues to rise sharply, reaching 30pc by 2014.

In each of these fast-industrializing, energy-hungry societies, per capita oil use will continue to crank up from its current low base. That’s why global crude demand will soar over the medium-term, even if Western growth barely recovers.

The BRICs’ emergence is a trend of massive economic – and political – importance. The painful de-leveraging process associated with “sub-prime” means the world economy will be haunted by systemic risk for years to come. Countries with large reserves, though, will be able to stabilise their banking systems, defend their currencies and boost their economies without resorting to yet more borrowing or (even worse) the central bank’s printing press.

While accounting for a fifth of the world economy, the BRICs now control no less than half of the world’s currency reserves. Excluding Japan, the G7 nations have only 6pc. And, in today’s climate, reserves amount to raw power.

For years, the G7 has largely excluded the BRICs’ from the institutions that are meant to oversee the global economy. Brazil is the world’s 10th-largest economy, yet Belgium has more IMF votes.

So, we shouldn’t be surprised the BRICs are this week holding their own summit - in the Russian city of Yekaterinburg. Western leaders will hold their breath – at least those who are economically-literate. If the BRICs decide to get nasty, and lend less money to the debt-soaked “advanced” nations, the deepest Western recession in 50 years could get a whole lot worse.

The sub-prime debacle and its fall-out have emboldened the “emerging giants” to demand a bigger say in the management of the global economy. That’s an inevitable long-term trend, which the West is unwise to resist.

In the here and now, though, whatever the West says or does, the BRICs and the other emerging markets are making their presence felt by pushing oil prices “fundamentally” higher.

These economies are home to no less than two-thirds of the world’s population. They’re in the midst of the fastest, most widespread industrial revolution the world has ever seen. Demand destruction? Don’t make me laugh …

OSBORNE SHOWS HE GETS IT ... OR MAYBE NOT

George Osborne gave a half-decent speech last Tuesday – another one! Speaking to the Association of British Insurers, the Shadow Chancellor declared the Tories’ “immediate priority is to restore Britain's international credibility and preserve our credit rating with a clear plan to deal with the huge budget deficit”.

Last month, Standard & Poor's downgraded the outlook for the UK’s credit rating from “stable” to “negative” over concerns that ten years of Gordon Brown’s spending, and today’s equally irresponsible bank bail-outs, could see our national debt breach 100pc of GDP.

This is a very large number - but not exceptional among the world’s ageing democracies. What’s spooking the ratings agencies is the eye-watering speed at which the UK’s national debt is growing – and the resulting extremely sharp rise in gilt issuance over the next few years.

“Ratings agencies and international investors are looking beyond the next election to a potential Conservative government,” said Osborne, “for reassurance Britain will take steps to control our surging national debt”.

This column has long warned of a UK sovereign downgrade, stressing the need for a credible plan to breach our fiscal gap. Now a senior politician has shown he “gets it”.

Or does he? Osborne also claimed in his speech that the Tories “have consistently underpinned our economic policy with a firm commitment to fiscal responsibility”. Er, actually, that’s not true.

For most of the last four years, the Cameroons have pledged to stick to Labour’s absurd spending plans. Some of us were screaming about Brown’s massive borrowing and off-balance-sheet debts. But Osborne and his team turned a blind eye, pledging instead to “share the proceeds of growth”.

The Tories repeated this vapid phrase ad nauseum, making the disingenuous claim they would pay down debt but still match Brown pound-for-pound as he spent taxpayers’ cash with abandon.

In recent months – and it has only been a few months – the Tories have begun to change their tune. Faced with a fiscal melt-down, they’ve toughened up their rhetoric and started to sound as if they’ve grasped how the gilts market works.

But Osborne’s speech didn’t give a single detail about how he will control spending. And when health spokesman Andrew Lansley made some comments a day or so later, the Tory High Command displayed it hasn’t yet got the stomach for the tough decisions that need to be made.

The Tories intend to protect the NHS and aid budgets in 2011-14, Lansley explained, but other departments face cuts. The man was speaking the truth.

It is precisely because Team Cameron has been so vague on fiscal policy for so long, so desperate not to offend anyone, that it now needs to show it truly means business. Yet, outrageously, Lansley’s political masters dismissed his words as a “gaffe”.

Liam Halligan is Chief Economist at Prosperity Capital Management