Hamish McRae: It's painful at the pumps, but oil prices show the market is working

There is still a lot of oil to be found, but probably not anything really big

So what is the next thing that might clobber the world economy now that the Greek debt collapse has been postponed for a while? It must surely be the oil price. We are very aware of this at a personal level every time we fill up the car. And, as tensions with Iran mount, we are becoming aware of the economic consequences of any disruption in oil supplies from the Middle East. But there is an aspect of the energy market that has rather crept up on us, and it is this.

We are running into a squeeze on oil supplies before the recovery has really got going. Every previous oil shock has come after a long economic expansion, with a surge in the oil price signalling (and contributing to) the end of the boom. Now the Brent oil price is back to $120 a barrel, yet the economic output of the developed world is still below its peak in 2007/8. This has never happened before.

There is a simple, but not very comforting explanation. If you look at total world economic output, it is indeed well past the previous peak, for growth in the emerging world has more than offset decline in the developed world. As a result, global demand for energy is very strong; it is just that not much of that additional demand has been coming from our bit of the world. As the US recovery deepens and if and when the eurozone shows some growth, demand from the developed world will pick up and the pressure on supplies will become really intense.

So what will happen to supply? Let's leave aside the possibility of short-term disruption as a result of rising tension with Iran, for there would be extreme outcomes there that don't really bear thinking about – oil at $200 a barrel or more. In the past, any rise in the price has been a spur to exploration and development. Fields that are barely profitable at $80 a barrel become extremely profitable at $120 a barrel.

But this is "difficult" oil, for getting it out remains a huge technical challenge. Sometimes things go wrong, as they did for BP in the Gulf of Mexico. Supplies of "easy" oil, for example in the giant fields of the Middle East, are not rising. The world's largest oil field, the Ghawar field in Saudi Arabia, was discovered as far back as 1948 and seems to have been in decline since 2005. Looking ahead, while there is doubtless a lot of oil still to be found, it seems unlikely that there is anything really big out there, certainly not on the scale of the giant fields of the Middle East. Yet demand relentlessly rises. So what gives?

There is one great imponderable. We have little idea of the possible scale of "unconventional" oil and gas that may come from shale, particularly in North America. There have been forecasts that North America may become independent of imports, thanks to this, and the International Energy Agency's energy report last year asked "Are we entering a golden age of gas?" It argued that the reserves of unconventional gas were as large as those of conventional gas and that a huge increase in its production would fuel the world economy through to 2035. Gas would be the main additional source of energy, leaving oil for the things that only oil can do, mostly transport. There are well-publicised environmental concerns and these need to be taken seriously, but from a macro-economic perspective the IEA thesis looks credible enough.

So you could sketch an economic outlook that looks something like this. Over the next few years, expensive energy will become more and more of a constraint on growth. The oil price (which affects all other energy prices) will not fall back and there is a danger of a surge.

But, on a long-term view, we need expensive energy to drive both conservation and the development of unconventional sources. The market will be doing its job, even if that makes for pain at the pumps.

The 50p tax rate is a revenue loser

Sometimes economic data turns out worse than forecast, but sometimes it turns out better. Last week, the retail sales numbers for January were very strong and now we have a larger surplus on our national accounts than expected: £7.8bn. The Government seems on track to meet the target set in last year's budget of borrowing £122bn, rather than the £127bn expected by the Office for Budget Responsibility last November. It may even be close to the £116bn target outlined by Mr Osborne in his first budget in 2010. This is still 7.8 per cent of GDP, but it is a lot better than the 11.1 per cent the Coalition inherited.

Nearly all the improvement has come from lower-than-expected spending: up only 1.6 per cent this fiscal year, compared with an OBR forecast of 3.6 per cent. Tax revenues were well up in the early part but seemed to be tailing off. Self-assessed income and capital gains tax revenue in January was up only 0.9 per cent on 2010/11, suggesting that the 50p tax rate may be losing money, rather than raising the £3bn the Treasury expected.

h.mcrae@independent.co.uk