Hamish McRae: Crude prices may have peaked but developing countries hold the key

Could that have been the peak in the oil price? It is such a hostage to fortune to try to call the top of any market that any such suggestion has to be hedged with qualifications and, in this instance, there may well be more peaks in the coming weeks and months. It is probably also true that, unlike in previous oil booms, this one will not be followed by an oil slump. But I think it is worth acknowledging that the oil price is high enough now to start to force change in people's behaviour, which it has to succeed in doing if we are not to have another and even more damaging oil shock ahead.

The issue about the peak in the oil price first, then some thoughts about a credible future path for prices. All the commodity markets have a frothy feel to them at the moment. There have been some sharp falls, for example in the wheat price – indeed, food prices in general seem to have ended the upward path they have sustained for the past 18 months. Quite how far prices will eventually come back will vary from commodity to commodity, for in some cases there has been a speculative element that has pushed the price beyond economic fundamentals. Obviously, the greater the speculative excess the greater the potential for a fall.

But oil is different from most other commodities. It is vastly more important; it has fewer substitutes and, for some applications, none at all; and there is a long-term problem of supply. To see its importance, look at the first graph, which shows the amount of world GDP that is spent on oil. At the moment, about 6 per cent of global GDP is being spent on oil, a huge increase on the proportion during the 1990s and early 2000s. But according to these calculations by the Bank Credit Analyst group, back at the last peak at the end of 1979 the proportion was higher still, more than 7 per cent. So while the real price of oil is higher now than then – it was equivalent to about $90 in today's money – and more oil is being produced, the world economy is much bigger so the burden accordingly is less now than then.

Still, even 6 per cent of the world economy is huge and money spent on oil is money not spent on something else, so this does result in an enormous shift of resources from the oil-consuming nations to the oil-producing ones. So, while this is not as big a shock in total as in 1979, it ought to be big enough to change behaviour, at least in the developed world. Trouble is, changes in the developed world matter less now than they did 25 years ago.

The next graph shows the long-term shift in the balance of demand for oil away from the developed world to the developing one. Crossover comes in the next couple of years. But look at the other graph. In the 1970s, there was a sharp fall in demand from the developed world in response to the price shocks. This time, that fall is less evident. That could mean two things. It could be that, thanks to a generation of efforts to curb oil use, it is harder now to economise; or it could mean that we are at the early stages of slump in oil demand and that as growth slows we will see this decline steepen.

One tiny bit of evidence supporting the latter view came yesterday with a report from Reuters that provisional figures from HM Revenue & Customs, which are based on fuel duty receipts, show slight falls in petrol and diesel use in April compared with a year ago. That is either a straw in the wind or to cite it is clutching at straws: we will see. But it does follow a similar trend in the US, where people are evidently driving less in response to the surge in fuel prices.

However, while the developed world may follow the path of conservation, there is not much evidence that the developing (or perhaps one should say the newly industrialising) world will do the same. As you can see, previous oil shocks had little impact on demand, but then the absolute amounts of oil being consumed were much lower. So far, there has been no evident fall in demand from developing countries, and as noted above, they are now almost as important as the developed world. Why no fall? Partly, it must be because of the strong underlying growth but there has also been a short-sighted policy response. One of the policies adopted by many developing countries has been to try to shield consumers from the impact of higher oil prices by subsidising the stuff. You can understand the pressure to do so but this cannot be sustained for long and there are signs that some subsidy schemes are now being phased out.

So how should one read all this? My feeling is that this time there may be a slight overall decline in global oil consumption over the next couple of years, with falls in the developed countries offset by a slower increase in demand from the developing ones. As for prices, I like the conclusion of the BCA team that put together these graphs: "A technical correction in oil prices is overdue, and may have started in recent days. However, below-market prices in many developing economies are shielding consumers, thereby propping up global oil demand and putting a solid floor under prices."

Medium-term, as growth recovers, perhaps in 2010/11, then the pressure will be on the oil price again.

What about supply, though? One thing you can be sure of: at this price, the oil majors of the West will be squeezing everything they can out of production. There is no point in lecturing them about trying to do more, as our Prime Minister seems to have been doing yesterday. The market is doing that already. The bigger question is whether the Opec producers can do more. In the short-term, the answer seems to be no. Technical and practical difficulties are restricting supply, not political decisions. Opec is not really acting as a cartel in the sense that a cartel holds down supply in order to drive up the price.

What will happen is that the present price will stimulate investment in new fields – there was a modest announcement yesterday by our own Government that a couple of new fields in the North Sea would be developed and that some existing ones would have investment that increased their output. But short of something really big happening – a new field on the scale of the North Sea or bigger – it is really very hard to see production running ahead of demand for long. Unless, big unless, the slowdown evident in the developed world broadens into a global economic slump. But we don't want that, do we?

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