Why oil price rise may hit you more than just at the pump

Oil broke through US$50 ($75) a barrel last week for the first time since October before profit takers caused it to slip for the first time in 72 days. Photo / AP

You've probably noticed you're starting to pay more to fill up the car with petrol again.

That's because global oil prices have just had their biggest rally in seven years.

Oil broke through US$50 ($75) a barrel last week for the first time since October before profit takers caused it to slip for the first time in 72 days.

Since hitting lows below US$30 in February barrel prices have risen almost 37 per cent.
The rally has been driven by demand side confidence as the US and Chinese markets recovered from their horror start to the year.

And by constraints on the supply side. In the past month there have been major production issues in Canada due to the Alberta wildfires.

There have also been militant attacks in Nigeria and political upheaval in Venezuela.

US production has also dropped, the number of oil rigs operating in US fields was down to 316 last week - from 646 this time last year.

If the rally continues it has the potential to dramatically and quite rapidly change the dynamic of the global economy.

Our continued reliance on fossil fuel for transport and energy, as well as manufacturing of plastics and fertilisers make it the most economically important traded commodity.

It flows through everything in modern economics because of the huge influence its price has on inflation or deflation.

The extra $20 or so a week that a higher oil price could cost you to fill your car pales into insignificance when you consider its ability to affect interest rates and currency markets.

If oil keeps rising then inflation will start to return to the US economy, and ours. The US Federal Reserve will be freed up to implement the interest rate hikes it has promised this year.

The US dollar would rise and ours would fall. Meanwhile stronger inflation and a lower value dollar here would take pressure off our Reserve Bank to cut rates.

The bank would have time to see whether an oil price rebound flowed through to other commodities - like dairy.

There is a mild "real world" correlation between oil and food commodities because energy costs are so important, particularly in the Northern Hemisphere.

But beyond that, sentiment in commodity markets has been an important driver in the past couple of years.

Rising oil and the return of inflation would likely be good news in the short term, at least for our relatively low cost dairy producers.

There are some big "ifs" here of course.

Oil's recovery is unlikely to be a straight line affair. Many traders in the US are picking another correction is imminent as short term supply issues are resolved.

It is likely to be a case of two steps forward and one step back over the next year. Let's hope so.

The rally offers a timely reminder that the gritty real world of drilling and processing carbon products is dynamic and volatile.

The low interest rate world that currently underpins a global boom in stocks and property will not last for ever. Oil prices are the most obvious circuit breaker.

There's a warning here.

Perhaps when the prevailing economic dynamic changes it will do so in a slow, steady and orderly fashion giving investors plenty of time to reallocate their capital, property developers time to finish their projects and heavily leveraged homeowners time to pay down their mortgages.

But it usually doesn't.