SMEs warned of oil prices but economists say strong labour market will ensure consumers handle the cost

Businesses will be hit with higher oil prices this year as the price of a barrel prepares to reach $US100 and the Australian dollar begins to decline in the second half, but one expert says the costs will be passed on to consumers as wages and labour conditions improve.

The comments come as Qantas said this morning it may have to start increasing airline fees in order to accommodate for the higher oil costs, which economists are pinning as a sign of a global recovery.

CommSec economist Savanth Sebastian says predicting oil prices is hardly an exact science, but also notes there are good indications of where crude will be heading this year.

“Forecasting oil prices in one direction is easier than telling the magnitude of how it’s going to travel,” he says.

“There is more concrete evidence that the recovery is here to stay. The recovery in the US is gaining traction, and that will drive oil prices higher. From a global perspective there is also speculation now that OPEC nations have been increasing production targets… but those are set to be modest.”

Indeed, major banks are predicting prices to increase. Macquarie says the average price will reach $US97 this year, with Goldman Sachs predicting a $US100 price this year, moving to $US110 next year.

Currently the price of oil is sitting at about $US90 a barrel.

As a result, CommSec says motorists and businesses should definitely start preparing for petrol increases, to the tune of three cents a litre over the coming fortnight, at least. After that, prices will keep increasing, which is certain to have an impact on consumer confidence.

“In terms of the impact for retailers, transport and consumers,” Sebastian says, “it’s probably a bit more mixed. We’ve had the strength of the Australian dollar curbing gains in oil and petrol prices, which are currently at just over two year highs.”

“But we expect the Aussie dollar to weaken. As that happens, and as oil prices increase, it means consumers are going to be hit with this double-whammy effect on petrol prices. That will be passed on to consumers.”

And it’s already happening. This morning Qantas chief Alan Joyce told The Australian Financial Review the company is considering raising fares to curb that rise in oil prices – by far the biggest expense for airlines.

“If the competitive dynamic is such that all carriers are in the position where they need to increase fares, then we’ll take advantage of that,” he said.

Rising airline fares would have a significant effect, considering business travellers are still backing away from lengthy trips, especially to overseas destinations. And Qantas is facing continued pressure from low-cost airlines such as Tiger and Virgin Blue.

But Sebastian points out the situation isn’t as bad as it seems for both businesses and consumers, and says rising oil prices won’t hurt a domestic recovery or shoo consumers away from spending their cash.

“Rising oil prices will affect businesses in a couple of ways. It will increase the cost base, yes, and businesses need to be prepared for that. But the Australian dollar is still quite storng on average – we expect it to settle at about $US91-92c this year, and the long-term average is in the 70s.”

“The other benefit will be that they will pass that on to consumers. And because of the strength in the labor market, particularly the effect on wage gains, they will be able to handle that type of cost.”

Sebastian says the retail sector is having to absorb a lot of those rising costs due to ongoing discounting. But he also says those conditions are beginning to thaw, and that the strength in the labor market will ensure higher prices are sustained.

“The long-term factor here is that it will have an inflationary impact, and I guess that’s why the Reserve Bank has been raising rates ahead of inflation trying to get ahead there.”

A sustained period of no interest rate movement will help consumers spend, Sebastian says, although another hike is expected in the second quarter.

“I think the pass-through effect will take place. It will add to inflation, but it’s well contained right now… but the real inflationary impact will come next year.”