Oil: The latest shock

Published October 23rd, 2000 - 02:00 GMT

According to the latest International Monetary Fund (IMF) "World Economic Outlook" released October 2000, the future of the world economy looks bright. The IMF forecasts that the world economy will grow by 4.7 per cent this year and 4.2 per cent next year, out of which it expects the richest industrial economies to slow down to a still robust 3 per cent growth rate. The only thing that might upset this rosy picture is the price of oil.  

 

The effects of oil price changes have long been feared to the extent that economists have often referred to them as "Oil price shocks." Nonetheless, not everyone suffers during times of higher oil prices; in particular it is those who are net exporters of oil that enjoy it most.  

 

Oil prices have increased sharply in the last 18 months, rising from under $12 a barrel in 99, to shoot past $30 in the second and third quarters of 2000. Oil prices are now at 15-year highs in both real and nominal terms (IMF).  

 

The first explanation given then was that demand simply outstripped supply by around 2 million b/d. Big consuming countries such as the US managed to pressure OPEC members to increase their output by 1.7 million barrels a day.  

 

The results were immediate as April prices fell sharply, down to $23-$24 a barrel. Following this agreement and wary of the long-term effects of high oil prices on the world economy, OPEC members agreed to informally define a target price band of $22-$28 a barrel.  

 

If the average prices for the OPEC crude basket falls below $22 or exceeds $28, OPEC's production would be decreased or increased by 500,000 barrels a day, respectively.  

 

Yet, in recent months, oil prices have shot up once again, and OPEC members who had convened in Vienna on June 21 decided to increase their production quota by a further 800,000 barrels a day as of July 1. Oil prices reacted by going higher since market makers had expected more of a production increase.  

 

OPEC members claim that although there is a link between crude prices (OPEC) and product prices, the link is neither direct nor proportional, and the real reasons for the high prices are the taxes imposed by Western countries.  

 

For example, 68 per cent of the final price of oil products within EU countries is tax, 16 per cent goes to refineries and 16 per cent to oil exporters.  

 

Contrary to the first view, the Western world mostly those countries that import oil argue that it is OPEC members who exercise predatory pricing, building upon their market- cartel position as a major supplier of oil to replenish their budgets.  

 

A third explanation for the recent price rises is that the world has reached a stage of limited capacity to increase production, with the exception of Saudi Arabia and Kuwait.  

 

Higher oil prices mean higher input costs for importers. Assuming aggregate demand stays put, firms would produce less at any given price. It also means that prices shoot up higher (inflation) and output falls.  

 

This could cause central banks to raise interest rates to prevent their economy from heating up, and consequently the higher rates would slowdown economic activity, choke off investments and lower GDP.  

 

Higher oil prices also mean that oil exporters (OPEC) receive more income and can thus save the extra windfall or recycle their extra oil revenues by importing more from the rest of the world. If that holds, the overall slowdown effect onto the global economy may be subdued.  

 

Indeed a recent Organisation for Economic Cooperation and Development (OECD) study has even concluded that the oil exporting countries spend 80-90 per cent of their high oil revenues on foreign imports within the first two years. 

 

The recent depreciation of most world currencies against the US dollar meant that countries had not only to deal with the direct impact of higher oil prices, but also cope with spending more of their local currencies in order to finance the purchase of oil, which is traded in dollars.  

 

Economies in the Middle East may be classified into oil economies and non-oil economies. Higher oil revenues do not only benefit those oil exporting countries, but indirectly impact the non-oil-producing Arab countries, such as Jordan and Yemen that witness a rise in the transfer of workers' remittances into their domestic economy.  

 

Indeed Jordan enjoyed its best years when the GCC countries were booming and consequently net workers' remittances were at their highest levels. If you combine the sum for oil revenues in the case of Yemen that generated from oil exports on one hand and from increased workers' remittances on the other, you get a spectacular number, somewhere in the range of about 60 per cent of GDP. 

 

Given that oil has both a high proportion of exports and a high proportion of government revenues, when the price of oil rises unexpectedly, governments could spend the extra windfall - by either increasing domestic expenditure or redirecting the funds to importation of goods from the rest of the world.  

 

Any fiscal surplus arising from higher oil prices, if sustained, will tend to increase the ability of countries to create new employment opportunities, addressing one of the long lasting challenges Arab countries had to face.  

 

On balance, there are still good reasons to expect the economic consequences to be less severe than in the 1970s when oil prices quadrupled, inflation soared and the world economy went into recession.  

 

The first argument is that the recent sharp rise in oil prices follows an equally sharp collapse over the previous two years, when oil prices had fallen to their lowest level in real terms since 1973.  

 

The second argument is that most countries have gradually reduced their dependence on oil, and hence are less sensitive to oil price turbulence.  

Finally and as mentioned earlier, in most countries the cost of crude oil accounts for a small share of the price of petrol, significantly lower than in the 1970s. It is Western taxes, at levels of up to 80 per cent that mute big changes to crude oil prices.  

 

Indeed governments simply increase their taxation on refined oil, even at times of falling crude oil prices, by that maintaining a stable petrol price for the consumer.  

( Jordan Times )  

 

 

 

© 2000 Mena Report (www.menareport.com)

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