Photo: The Telegraph
Jim O’Neill is widely known as the Goldman Sachs economist who coined the acronym BRICs.However, few people know that he has a pretty sophisticated understanding of oil.
“Many decades ago, I was awarded a PhD for researching oil prices and their consequences,” writes O’Neill in latest Viewpoints letter.
So, what insight can he offer regarding the surging oil prices?
Unfortunately, not much. His note is a minefield of caveats.
As I am occasionally fond of saying, I am not sure I learnt much in the nearly 3 years it took me to complete the research. Perhaps two things, one, doing an economics PhD in those days was basically a test of one’s sanity. Two, forecasting oil prices makes forecasting foreign exchange markets seem relatively easy (I learnt that later on really)…
Anyhow, what level of oil prices will start to cause renewed damage in terms of inflation and depressing real incomes? Unfortunately none of us know.
Eventually, he does go out on a limb to say that he’s not too concerned about the current level of oil prices.
And, in reality, I am of the school that quite strongly believes it is probably best seen in terms of oil-price-adjusted financial conditions to observe how strong or not any real economic damage can be. In this regard, so far, and especially because many leading nations continue to undertake steps to ease financial conditions – China and Japan being the two most important recently – it is probably not yet much of an issue. At some stage, though, it could become one.
O’Neill also shares some interesting insights as to how we should be looking at oil prices.
One aspect to all of this that increasingly fascinates me is the difference between “spot” prices and longer term prices. For many years, I have wasted time trying to think of the Holy Grail of the “equilibrium” oil price and, in this search, I settled on using the 5-year price as a simple broad guide. The attached chart shows the path of the 5-year price alongside that of the spot price. In my judgment, the 5-year price is probably a better guide of the true underlying supply and demand forces. In this regard, the chart shows an increasing divergence between the two as contrary to the 2000-08 and immediate post 2008 meltdown, the long term price appears to have “stabilised ” in an $80-100 per barrel range.
It’s interesting that despite earning his PhD in oil prices, none of O’Neill’s 11 predictions for 2012 addresses it.