IEEJ: March 2011

Special Bulletin
A Japanese Perspective on the International Energy Landscape (34)

March 9, 2011

Rising crude oil prices and their impact on world economy
Ken Koyama, PhD
Director
Strategy and Industry Research Unit
The Institute of Energy Economics, Japan
Crude oil prices have continued to rise. On March 7, the benchmark West Texas
Intermediate crude futures price gained $1.02/barrel from the previous day to$105.44/barrel, up more than $20/barrel from around $85/barrel in the middle ofFebruary. The North Sea Brent futures price remained high, closing the day at$115.04/barrel. The high crude oil prices have attracted attention as an internationalenergy market problem and are expected to decelerate the world economy. A sense ofvigilance has been growing gradually.
Indicating a sense of vigilance against the adverse impact of rising crude oilprices on the world economy is an interesting change seen in the correlation between
crude oil and stock prices. The 30-issue Dow Jones Industrial Average on the New York
Stock Exchange continued a moderate upward trend after rising above 10,000 in July
2010. It topped 11,600 in early 2011 and exceeded 12,000 in February. The latest peak
was 12,391 on February 18. Until the day, stock price hikes basically went together withcrude oil price rises. Until late last year, particularly, stock prices had a roughly positive
correlation with the WTI futures price. While stock prices continued to rise from early
this year, the WTI price slumped. Toward mid-February, the WTI price fell to around$84/barrel. The decline might have been attributable to an increase in crude oilinventories in Cushing that is a problem peculiar to WTI, as explained in “A Japanese
Perspective on the International Energy Landscape (30).”
Since the week of February 22 when the Libyan crisis entered a new phase on
the government's use of force against antigovernment movements and theintensification of confrontation, however, a new combination of rising crude oil prices
and falling stock prices has been seen. This means that crude oil prices have basically
had a negative correlation with stock prices. On March 7 when crude oil prices soared as
noted above, the Dow Jones average lost 80 points from the previous day to 12,090. In
this way, the correlation between crude oil and stock prices has entered a new phase. On
March 8, in fact, the Dow Jones average gained 124 points to 12,214 while the WTI
futures fell $0.42/barrel to $105.02/barrel. Their correlation thus remained negativeeven though the Dow Jones average turned up.
What would the background of the negative correlation be? A simple explanation
may be that the causality relation between the two economic variables has been1

IEEJ: March 2011

reversed. When stock and crude oil prices maintained their positive correlation untillate February, the macroeconomic trend (as reflected by stock prices) was an
explanatory variable against crude oil prices as an objective variable. At present, crude
oil prices might have become an explanatory variable against stock prices as anobjective variable. (This means that crude oil prices had been susceptible to themacroeconomic trend before the reversal and have shaken the trend since the reversal.)
But off course this is a too much simplistic view. Stock prices are determined by manyfactors, not determined by crude oil prices alone. Crude oil prices are also determined bymany factors, not determined by stock prices alone. It may be needless to say thatcomplex conditions of factors work to determine crude oil and stock prices.
But crude oil prices' relationship with stock prices (a mirror of themacroeconomic trend) directly indicates how seriously market participants view crude
oil price hikes on the intensification of the Libyan crisis, geopolitical risks behind theintensification and the crisis's spillover. Their relationship implies that the Middle
Eastern situation and crude oil prices are creating important risks to the world
economy.
In fact, discussions have grown rapidly about analyses on effects that crude oil
price hikes would exert on the world economy. For example, a Deutsche Bank report on
March 3 indicated that world economic (GDP) growth would be lowered by 0.4
percentage point if the benchmark crude oil futures price rises to $110/barrel and by 2.0
points if it soars to $150/barrel. Crude oil price hikes' negative effects on GDP areprojected to differ from region to region, depending on oil imports' economic weights, thesizes of net oil imports, and energy consumption efficiencies. The hikes are expected toexert a relatively greater impact on European countries and the United States amongindustrial nations and on Asian developing countries. As is known well, the fact thatspikes in prices of foods and resources including crude oil have caused growing inflation
fears and begun to affect citizens' livelihood has become an important matter of concern.
The Middle Eastern turmoil and crude oil price hikes have caused problems
particular to various regions. The Libyan crisis has had the greatest direct impact on oil
supply in Europe. The European economy, which has been plagued with the sovereign
debt crisis since last year, is viewed as vulnerable to the crude oil price spike. The
United States has faced the oil price problem at a time when it has begun to see brighter
economic signs including improvements in employment data. Given that economic
problems are expected to become the biggest focus for the next presidential election,
crude oil price hikes' emergence as an economic risk is of great significance to theObama Administration. In China, the stabilization of people's livelihood has become anurgent lesson with economic management priority given to inflation control ahead of theplanned leadership transition in 2012. China is thus forced to be vigilant with regard tocrude oil price hikes. At present, the world economy has gotten on a growth path, with
the Dow Jones average at high levels above 12,000 on the New York Stock Exchange.
However, concerns are growing about the future course throughout the world and inmajor countries.
2IEEJ: March 2011

Under such situation, all relevant countries will have to enhance their efforts
and cooperation to prevent crude oil prices from rising further and from exerting
negative effects on the world economy. Saudi Arabia has already expanded crude oil
output. Some other OPEC countries such as Kuwait and the United Arab Emirates havelaunched moves to increase crude oil production. Discussions have reportedly started onan emergency OPEC meeting to deal with the rapid crude oil price hikes. If thedestabilization of the Middle East begins to spill over to other oil producing countries,
oil consuming countries may have to take market-stabilizing measures including anIEA-coordinated release of oil reserves. If crude oil prices are excessively destabilized tocause an unusual spike, concerns may grow about speculative moves on the market, asseen in 2008. Then, the enhancement of surveillance on the market may become a focusof attention. In any case, all relevant parties will have to make efforts to fight against
crude oil price hikes that are becoming an important matter of concern in the world
economy and international relations.
Contact: report@tky.ieej.or.jp

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