Here's how higher oil prices pose a threat to the biggest part of the Australian economy

Prepare for more pain at the bowser. (Photo by Joe Raedle /Getty Images)
  • CBA’s commodities team forecasts that oil prices will average $US86 a barrel in 2019 – a gain of more than 10% from current levels.
  • Senior economist Kristina Clifton said Australian households are unlikely to absorb the impact of higher petrol without reducing spending elsewhere.
  • The net effect of higher oil costs could exacerbate the recent divergence between business conditions and consumer sentiment.

Oil has been rising steadily in 2018, and the commodities team at Commonwealth Bank think higher prices are here to stay.

After brent crude climbed back above $US75 a barrel on Friday, CBA now forecasts that prices will average $US79 a barrel in 2018 before rising to $US86 in 2019.

In view of that, CBA senior economist Kristina Clifton has provided research on the pros and cons of higher oil prices for Australia’s economy.

She said that a boost in Australia’s exports and terms of trades will be offset by more pain for Aussie consumers.

“The most direct impact of higher oil prices on households comes through the channel of higher petrol prices,” Clifton said, noting that demand for oil remains relatively inelastic.

“Around 62% of people use a car to travel to work. If petrol prices remain at elevated levels we may see some impacts on housing spending patterns.”

Clifton used two charts which highlight concerning trends for domestic consumption. The first shows a widening gap between household income and consumer spending:

And the second highlights the steady decline in household savings since the end of the global financial crisis in 2009:

Taken together, both charts clearly illustrate the spending pressures currently facing Australian households.

And importantly for the domestic consumption outlook, she said households are unlikely to absorb the hit to the hip pocket from the rising cost of essentials.

“Households are unlikely to cut down their rate of savings any further, particularly now dwelling prices are falling,” Clifton said.

“So higher fuel bills are likely to be paid for by cut backs to spending on other goods and services.”

To demonstrate the relatively inelastic demand for petrol in the Australian economy, Clifton noted that more than 90% of households have a car while around 62% of Australians use a car to drive to work.

She said there’s also the risk of a domino effect stemming from higher oil costs that will put upward pressure on electricity prices.

“Domestic gas prices have become increasingly linked to international prices in recent years. And electricity prices have become closely linked with domestic gas prices,” Clifton said.

But on the flip-side — and citing that same link between gas and oil prices — Clifton said higher oil prices will provide a boost for the export component of GDP.

The surge in LNG production since late-2016 has seen Australia become a net exporter rather than a net importer, which means the dollar-value of our exports and terms of trade both stand to benefit if higher oil prices flow through to LNG.

In that scenario, the economy could also get a boost from further investment in LNG projects and higher government tax revenues.

However, Clifton noted that taxes paid to the government from LNG and oil projects are back-weighted because LNG companies are allowed to fully depreciate the value of their capital investments before paying any tax.

The research indicates that higher oil prices could exacerbate the recent divergence in Australia’s economy between domestic business conditions and consumer confidence.

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