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Oil's Role in the Global Economy

The world has become less dependent on oil. The OECD estimates that in 1980, the global economy needed 0.31 metric tonnes of oil (or equivalent energy input) to produce $1,000 of real GDP (in 2000 dollars). In 2004, it took 0.22 tonnes.
The reduction was greater in the U.S. (0.35 to 0.21) but less in Japan (0.18 to 0.15) and most European countries, in large part because they were more efficient to begin with.

In addition, oil's share of total energy production has dropped. When it comes to oil consumption as a share of GDP, the U.S. is about average for the world. Europe will generally be less affected by an oil price hike because the Continent uses less energy relative to GDP and because higher energy taxes mean oil consumption will fall less than the world average. This is because the retail price of energy is less tied to the cost of crude. Japan will be affected more than Europe because it imports almost all its energy, while in Europe and the U.S., a high percentage is domestically produced. China could feel the biggest impact because it has a slightly higher ratio of energy use to GDP than the U.S. and imports more of its energy.

Here's a look at how each of our four scenarios might play out:

1. Conflict Contained

Our base case assumes that the fighting is limited to Israel, Palestine, and Lebanon. There is no impact on oil supplies, and prices drop slowly from current levels, which have a risk premium built into them.Oil falls below $70/barrel by year-end and to $60/barrel by the end of 2008. The world economy continues to expand, with the U.S. slowing to 2.5% growth in 2007 from 3.5% in 2005 and 2006 but with Europe speeding up this year and Asia remaining solid. Headline inflation rates drop because of the decline in oil prices.

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* David Wyss is Chief Economist with Standard & Poor's, New York.