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jeff rubin

Oil pumps in operation at an oilfield near central Los Angeles on February 2, 2011.

How high must oil prices go before they start killing the very demand that feeds them?

Everybody from the International Monetary Fund to the International Energy Agency (IEA) is warning of dire economic consequences if today's triple digit oil prices persist.

Curiously though, the IEA, which is warning of a potential global recession due to today's oil prices, is also predicting an almost a one-and-a-half-million-barrel-a-day increase in world demand this year. And judging by their recent track record, this forecast, like the one it made early last year for 2010, will once again be on the light side.

Somber warnings from leading world institutions aside, there is no evidence yet of demand destruction in the places that have been pushing world consumption for over the better part of the past decade. Preliminary data on apparent fuel consumption show Chinese oil demand, already closing in on ten-million barrels a day, continued to grow at a double-digit rate in March for the sixth consecutive month. That doesn't sound like demand destruction to me.

Of course, that is not to say there won't be demand destruction in the future as oil prices continue to rise. All past oil shocks have resulted in recessions and falling crude prices, and there is no reason to expect the coming one will be any different.

Given how high oil prices will likely rise ($200/barrel?) and the likely lack of fiscal counter measures from deficit-ridden governments when the economy does finally keel over, there is potentially even more room for demand destruction than during the last recession. Keep in mind, the last recession was severe enough to register the first annual drop in world oil consumption since 1983.

But what is still lacking for demand destruction to happen is the huge round of monetary tightening that always attenuates oil shocks. It's no doubt coming. Just look how interest rates are already chasing runaway energy and food inflation in the world economy's new growth areas, China and India.

Facing 5.5 per cent inflation, the People's Bank of China has already increased interest rates four times over the past six months, and inflation will soon force other central banks around the world to follow their lead. Just as they did last time, those rate hikes, along with the burden of skyrocketing fuel bills, will eventually knock the economy back into recession.

But until then, it is a little too early to focus on demand destruction. In the meantime, a fuel-hungry world economy will push oil prices to new record highs.

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