Oil prices should be Republic's wake-up call

Economics/Cliff Taylor: We missed out on the oil crisis during last year's Iraq war. Maybe we are going to get it now. If sustained, rising oil prices pose a threat to economic growth. And even if this is just a temporary price spike, it should be a "wake-up" call to countries such as Ireland that still have a heavy reliance on imported oil.

Oil markets - and financial markets in general - reacted in a remarkably relaxed fashion to the US-led invasion of Iraq, confounding forecasts of a prolonged hike in prices. It would be a quick and successful invasion, the markets reckoned, and the threat of supply disruption was small. As the statue of Saddam was pulled down in Baghdad, it appeared the markets had got it right.

Now it looks different. The situation in Iraq seems to deteriorate by the day. Fears of a terrorist strike on oil infrastructure are back on the agenda. And questions are being asked about the state of relations between Saudi Arabia and the US. In the past, the Saudis tried to ensure price stability - now the question is whether they are willing, or able, to do so in future and whether OPEC will be able to pump much more oil.

These geo-political factors have combined with a low level of oil stocks to drive prices higher. Stocks are low partly for structural reasons as oil companies try to become more efficient by cutting inventory levels. Meanwhile, demand has picked up because of the world economic recovery - and also because of rising demand from China. In the background are long-term factors, including some predictions of a falling oil output trend in the years ahead and an inability of supply to meet demand in the long term.

It goes without saying that a sustained rise in oil prices threaten the economic outlook. The boffins in the International Monetary Fund (IMF) have calculated previously that every sustained $5 (€4.23) increase in oil prices cuts 0.3 per cent off world growth. Oil prices have risen from $25 a barrel a year ago and $30 a barrel at the end of 2003 to $40 a barrel now. The IMF's 4 per cent international growth forecast for this year and next is based on $30 a barrel, so if prices hold where they are this could quickly be cut back closer to 3 per cent.

However, the rise, if it continues, could do some serious damage. If prices rose to $50 or more - and stayed there - it would threaten to kill off the recovery completely.

The key thing, of course, is how long prices will remain at high levels. There is no consensus among analysts on the likely trend, though the balance of opinion is that prices could ease back. A brief spike followed by a fall back to $30 a barrel would do little harm. The danger is that prices hold their current highs or climb higher. Perhaps more damaging than the mechanistic calculations of the impact of every $5 a barrel rise on GNP would be the impact on consumer and business confidence.

What of the Irish economy? The most obvious impact is on the rate of inflation. Yesterday's consumer price inflation figures reflected this, with an increase in transport costs and fuel prices helping to push the index up, although it remains at a low annual rate of 1.4 per cent. Goodbody stockbrokers calculate that if prices remain at current levels, the average rate of inflation this year could be 2.4 per cent, 0.5 of a percentage point above their earlier forecast.

The impact on growth is more difficult to calculate, as it depends on a diverse range of factors, including the incalculable confidence factor.

Mr Gerard O'Neill of Amarach Consulting argues that the Irish economy is relatively highly dependent on oil, when compared with most other economies. His research indicates that the "Celtic Tiger" boom was driven on oil, with Irish oil consumption per capita doubling between 1989 and 2001.

Mr O'Neill argues that, if prices stay at current levels, the annual GNP growth rate here could be knocked by 1-1.5 percentage points.

As ever with statistics, there are other ways to look at Irish oil dependence. OECD figures for the overall energy intensity of the economy - measuring the way the economy uses all the main types of energy in 2001 - show Ireland weighing in about 17 per cent below the EU average. These figures would be heavily influenced by the type of industry in a country - in Ireland there has been a huge growth in sectors such as ICT and pharmaceuticals, which produce very high levels of output compared with output used.

IBEC argues that this indicates the energy efficiency of industry here and suggests that higher prices will thus hit quickly. While Amarach's research would suggest otherwise - they calculate that for every 1 per cent increase in GNP here we use considerably more oil than other economies, there are a few indisputable conclusions.

One is that energy use has soared, increasing by some 40 per cent over the last decade, compared with 10 per cent in the EU as a whole. The second is that we remain hugely reliant on imported products, despite the Kinsale field. And the third is that, whatever the energy diversification, we still rely on oil for more than 55 per cent of total energy. Diversification has been mainly away from coal and towards gas - including the building of gas-powered electricity stations. Unfortunately, gas prices tend to move up in tandem with oil, as big power producers push up demand and the price of gas as oil becomes more expensive. Meanwhile, Ireland has been very slow developing alternative energy sources. It was only this week, for example, that clearance was given to feed wind power into the national grid. And such is the fuss about waste incinerators that we have not debated their potential role as power generators.

There are obvious issues for policy here. But the more immediate issue is the planned introduction of a carbon tax next year. The Government has committed to do this, but if oil prices do not come back, it would be strange for policy to add further inflationary fuel as the market mechanism would itself be encouraging people away from heavier fuels.