Jeremy Warner's Outlook: Oil pushes world towards recession

Yesterday's discussion document from the Treasury – Global commodities: a long-term vision for stable, secure and sustainable global markets – is long on analysis of the inflated oil price but almost entirely bereft of meaningful solutions. To be fair, this is largely because there are none, or at least none which are within the Treasury's gift.

It has long seemed to me that the only thing likely to bring the oil price back to earth is a global recession, and that is exactly what very high oil prices seem destined to bring about.

High oil prices are one of the main causes of today's elevated rates of inflation. Central bankers feel obliged to treat these pressures with higher interest rates, which perhaps sooner rather than later will poleaxe growth in the developed and developing world alike.

The only reason the inevitability of this outcome is not already reflected in lower energy prices is because the balance of supply and demand remains so tight. Heightened demand will persist until it loses its capacity to pay, and, too late, the oil price will then fall. Tony Hayward, chief executive of BP, dismisses the idea that speculative activity has contributed to the rocketing oil price as a myth.

I suspect he is wrong about this, for it seems to me manifest that oil purchases by investors with no ultimate use for the stuff other than to sell it on at a profit are an important contributor to today's elevated levels of overall demand.

Yet this doesn't necessarily mean that the price is a false one. Whether the causes are speculative or not, the high oil price sends out a number of important signals. The main one is that demand needs to fall and supply to increase. The main levers of supply continue to lie with politically unstable or unpalatable regimes in the Middle East, Russia and South America. As Mr Hayward observes, the chief constraints on supply are political, rather than geological.

International oil companies, such as BP, with access to the capital and expertise to pursue development have found themselves shut out of the major producing areas of the world, some of which are deliberately holding back reserves in the almost certainly mistaken belief that they provide a store of value for future generations. In fact, the rationing of supply only creates incentives to find alternative energy sources.

We cannot do much either about the subsidies that in many areas of the world inhibit the stabilisation that would occur in consumption if the pricing mechanism were allowed to work as it should.

Nor is demand entirely within our control. In the developed West, we can make ourselves more efficient, or develop alternatives to hydrocarbons. But we can do nothing to stop the structural increase in demand coming out of development in Asia. As I say, the end game looks ever more likely to be global recession. In those circumstances, producer nations, the apparent beneficiaries of sky-high oil prices, will suffer alongside consumer countries.

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