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When a single bargain struck by a trader on the floor of the New York Mercantile Exchange took oil to the $100 milestone last week it sent tremors across the world particularly to big oil consumers such as the US, China and India.
It is a fact that at $100 a barrel, oil is unaffordable for growing economies like China and India. China imported 44 per cent of its oil, worth about $45 billion, in 2005. At that time oil prices hovered around $70 a barrel. At $100 a barrel in 2007 it is expected that China's import bill will surpass $60 billion.
India is no better off. Its net oil import bill stood at $33 billion in 2006. The current year will see its rapid rise to over $45 billion.
Although China can afford to pay this heavy burden, thanks to its huge trade surplus, India is in a precarious position. The country's only comfort is that Indians working in the Middle East send large remittances of US dollars, which keeps the pain a bit manageable.
Why do developing countries and even developed countries tremble when oil prices shoot high? One major effect that high oil prices could have on economies is inflation.
The price of oil and inflation are often seen as being connected in a cause and effect relationship.
As oil prices move up or down, inflation follows in the same direction. The reason why this happens is that oil is a major input in the economy - it is used in critical activities such as fuelling transportation and heating homes - and if input costs rise, so should the cost of end products.
For example, if the price of oil rises, then it will cost more to make plastic, and a plastics company will then pass on some or all of this cost to the consumer, which raises prices and thus inflation.
The direct relationship between oil and inflation was evident in the 1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to around $40 during the 1979 oil crisis. This helped cause the US consumer price index (CPI), a key measure of inflation, to more than double from 41.20 in early 1972 to 86.30 by the end of 1980.
However, this relationship between oil and inflation started to deteriorate after the 1980s. During the 1990's Gulf War oil crisis, crude prices doubled in six months from around $20 to around $40, but CPI remained relatively stable, growing from 134.6 in January 1991 to 137.9 in December 1991.
This detachment in the relationship was even more apparent during the oil price run-up from 1999 to 2005, in which the annual average nominal price of oil rose from $16.56 to $50.04. During this same period, the CPI rose from 164.30 in January 1999 to 196.80 in December 2005. Judging by this data, it appears that the strong correlation between oil prices and inflation that was seen in the 1970s has weakened significantly.
Coming to the GCC economies, sure at $100 and above oil would bring more wealth to the countries. But experts predict it would also usher in an undesirable - higher inflation.
High oil prices will result in more money flowing into the GCC and "translate into greater pressure on inflation and on goods and asset prices," says Marios Maratheftis, Standard Chartered's head of research for the Middle East.
Saudi Arabia, the UAE and four other Gulf countries produce more than 15 million barrels of oil a day, earning $1.5 billion at current prices.
Regional governments are investing these record surpluses in development projects to diversify their economies. This has also strained supply of goods and created shortages, most notably in housing.
Analysts have raised their 2008 inflation forecasts after local currencies were led lower against the euro by the weakening dollar and housing shortages persisted.
Oil revenues of the six GCC countries, that also include Kuwait, Qatar, Bahrain and Oman, will probably rise 10 per cent in 2008 to $440 billion if the price of Dubai crude, a regional benchmark, averages $75 a barrel.
Spurred by the oil windfall, GCC economies have grown by an average of seven per cent annually over the past four years and the growth is expected to continue.
Total GDP of the six states rose sharply from $406 billion in 2003 to $712 billion in 2006, according to the International Monetary Fund (IMF).
It forecasts that GDP will grow to $790 billion this year and $883 billion in 2008.
The IMF also predicts that the six nations will spend at least $800 billion on domestic investment projects over the next five years, 75 per cent of that total in non-oil sectors.
Ironically, despite all the wealth and progress GCC nations face a double whammy - inflation from increased spending and price rise caused by the higher costs of imports because of a progressively declining dollar to which their currencies are pegged.
And it will be the middle and lower income earners who will be hit the hardest!
