Sunday, March 13, 2011
Osborne need not slip on high oil prices
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular piece is available to subscribers on www.thesundaytimes.co.uk - this is an excerpt.

Though it seems motorway service stations are no longer obliged to post their prices on the carriageway, other service stations do. Petrol is the most visible price in the economy. It is also the classic reluctant purchase. Who spends £80 filling up the car without thinking they would rather spend the money on something else?

For road hauliers and others in the transport sector, it is more than just painful. Britain alrfeady has t he highest duty level on diesel in the EU, and more than double the rate in some countries.

There is no easy answer. Fuel duties are an important part of the government’s fiscal reduction plans, with revenues from them predicted by the Office for Budget Responsibility (OBR) to rise from £26.2 billion in 2009-10 to £35 billion in 2015-16.

Merely cancelling next month’s planned 4-5p (duty plus Vat) increase will cost serious money, more than £1.5 billion according to the Institute for Fiscal Studies. Whether you get much political bang for such an expensive buck - cancelling a planned rise is not the same as a cut - is another matter.

That is why Treasury officials are beavering away on a “fair fuel stabiliser”, varying fuel duty according to the level of global oil prices to produce more stable prices at the pump.

This, as you may recall, was the Conservative policy in opposition - the government could do this in a fiscally neutral way, it was argued, because the public finances benefit from higher oil prices. But it was apparently condemned to death by a damning assessment from its own OBR. The OBR said a £10 rise in oil prices would produce a small net revenue gain, £100m in the first year, but a revenue loss of £700m in the second, as higher prices reduce non-oil profits and the corporate tax take.

The Treasury, however, is pressing on, taking on board the OBR’s analysis. The aim is to present a fair fuel stabiliser that does not pretend to be fiscally neutral in one or two years, but over the course of a parliament as world oil prices rise or fall.


Clearly the chancellor will not want to come up with anything the OBR rejects. But the fiscal watchdog would be failing in its duty if it does not point out the risks. If oil prices were to continue to rise, even when a measure of political calm returns to the oil-producing countries, the government would need to find other sources of revenue to replace the lost duty.

Even if oil prices fall, and they could if China is serious about targeting lower growth (7% rather than 10%) over the next five years, there would be the political challenge of raising duties when world oil prices are falling. But it seems we will get such a stabiliser on March 23.

All this presupposes that Britain is still on track for a recovery, admittedly an unspectacular one, and a falling budget deficit. What if the economy is blown off course by higher oil prices?

As I noted at the start, oil has been associated with difficult times in the past. There are even some out there who believe the recent great recession was caused, not by the financial crisis and the collapse of Lehman Brothers but the run-up in oil prices to $147 a barrel in summer 2008.

Let me try to cut through some of the myths. When oil supplies are cut off, as in the Opec (Organisation of Petroleum Exporting Countries) embargo in autumn 1973, the effects on the world econokmy are indeed recessionary.

Advanced countries depend less on oil than they used to but emerging economies are driving the global economy and they are as oil-dependent (because they have proportionately larger industrial sectors) as we were four decades ago. So the loss of, say, a significant chunk of Saudi production and an oil price of $250 a barrel would kill what has been a strong global recovery.

The effects of lower-level hikes in oil prices are less clear. Though global and British recessions have been associated with higher oil prices, cause and effect are another matter.

Britain’s last but one recession, which started in mid-1990, came before the big Gulf war affected rise in oil prices. High oil prices in the run-up to the recent great recession meant some central banks, including the Bank, were slower to cut interest rates than they should have been, but did not cause the recession.

Going back further, Britain’s recession of the early 1980s, and America’s 1982 recession, were caused by tight monetary policy, 17% interest rates in Britain, 18% in America, not high oil prices. This is the key lesson of past oil episodes.

Oil prices are tricky for monetary policymakers. Their short-term effect is inflationary but their long-term effect is deflationary. Most recessionary effects of high oil prices were when rates were raised too much in response to the initial inflationary shock, with not enough attention paid to subsequent deflationary effects.

Central banks appear determined to avoid doing this on this occasion. The Bank of England left rates unchanged last week, as expected. Rates will go up but in a softly-softly way, more of an easing off the accelerator than a slamming on of the brakes.

That should mean the world and Britain can grow through this mini oil shock. Barring, of course, very much higher prices, serious supply dislocation and panicked central bankers.