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Rising oil price has wider impact

Higher petrol costs 'act like a tax on consumption'

By Bina Brown


Financial Markets

(CNN) -- Higher oil prices are starting to cause havoc far beyond the petrol bowser. Slowly but surely, the rise in the price of oil is pushing up inflation and interest rates and affecting people's spending habits and share markets.

Where the price of oil is headed is anyone's guess. But predictions for the short term outlook range from the current level of around $74 to $100 a barrel by the end of the year before a possible retreat.

Mostly the outlook for oil prices comes down to supply and demand. With global production capacity at a very low excess (about 2 million barrels a day) and China ready to buy any oil there is, there is no shortage of demand.

Couple that with the problems facing most of the oil producing areas -- Nigeria, Venezuela, Russia, Middle East and the Gulf of Mexico -- the price of oil is not expected to retreat in the near future.

According to Ira Kalish, a director of global economics and consumer business at Deloitte Research, the spectacular rise in the price of oil over the past few years has had a much more tempered impact on the global economy than it could have.

He puts it down to the more efficient use of energy by major industrialized nations than in the 1970s when prices last shot up, the fact that prices are not yet near those highs and people's change in behavior.

"Until recently consumers in industrial nations acted as if the rise in the price of oil would be temporary. In other words, they failed to adjust their behavior accordingly. That fact, however, has changed in recent months. Indeed, consumer spending in the U.S. has slowed and the mix of automobiles purchased has shifted," says Kalish.

So, the oil shock hasn't been as onerous as could be the case.

That is not to say, however, that an increased price has no consequences. Indeed the world is already feeling the impact.

Rising oil prices have been inflationary. Inflation in the G-7 countries is at its highest level since the early 1990s.

AMP Capital head of investment strategy and chief economist Shane Oliver says most countries are raising interest rates as a result -- albeit off a very low base -- to keep inflation in check.

In Europe key central bank rates are still rising having hit 3 percent, in Japan rates have gone from 0 to 0.25 percent and in the United States there has been a steady tightening from 1 percent to 5.25 percent.

Oliver also says that higher petrol prices are acting like a tax on consumption which could, in turn, slow economic growth; Households which have to spend more on petrol, spend less on other goods.

Kalish says that a sufficient slowdown in economic growth would have a dampening effect on the price of oil, which could easily drop below $60 per barrel in 2006 if growth in the U.S. and China slow.

Meanwhile, the search for oil goes on, presenting investment opportunities for some.

As well as the current producers, there are the exploration companies, the service companies and associated suppliers and the transporters of bulk liquids could be considered.

Then there are the myriad alternative energy opportunities which might one day bring an end to the current concentration on oil.

If oil prices continue to push up in inflation and drive interest rates higher there could even be some bargains to be had.

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