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Recession risk unless oil prices fall further

Recession risk unless oil prices fall further

Oil prices must fall far, fast – and then stay low.

August 13, 2011 9:40 by

If history is any guide, another oil-induced recession may be just around the corner, at least for the United States and some of the other developed economies. Every time that the cost of oil relative to global economic output has hit current levels — and that’s even after sharp falls in spot prices this month — it has heralded a slump.

And while economists and analysts say a serious slowdown can still be avoided, many add that unless oil and energy prices fall much further and — most important — stay down, the world economy could be in serious trouble.

“We are in a danger area for the world economy,” said Christophe Barret, global oil analyst at Credit Agricole.

The warning signal flashing is what economists call the “oil expense indicator”: the share of oil expenses as a proportion of worldwide gross domestic product (GDP) (oil prices times oil consumption divided by world GDP).

Since 1965, this has averaged roughly 3 percent of GDP, and it has only exceeded 4.5 percent during three periods: in 1974, between 1979 and 1985 and in 2008.

Each period has seen severe global recessions.

In 1973/74, during the first global “oil shock”, oil prices rocketed after an Arab oil embargo in response to an Arab-Israeli war disrupted oil flows and triggered panic buying. In 1979, revolution in Iran knocked out much of the country’s oil output and was followed by a long Iran-Iraq war, bringing a second “oil shock”.

In 2008, propelled by a housing bubble, speculative buying of new debt instruments and a commodities boom, oil prices exceeded $100 per barrel for the first time and soared to a record high above $147, helping trigger financial crisis and the

worst slump since World War II.


This time, oil prices have soared following the loss of around 1.6 million barrels per day (bpd) of Libyan oil, uprisings across the Middle East and North Africa


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