SKYROCKETING OIL PRICE- A CHALLENGE FOR ECONOMY

FOZIA ISHAQUE (fozia.ishaque@hotmail.com)
Dec 03 - 09, 2007

World economy has been hit hard by a sudden record upsurge in oil prices recently. Abstract Oil prices, associated with bouts of inflation and economic instability over the last 30 years, have risen sharply and consistently. The oil price took a leap of around $20 a barrel from $79 in October 2007 in the US where a shortage in the US oil reserve was reported. It jumped by $9 to $88 a barrel and then went up by 12 dollar a barrel. Global oil demand, currently around 85 million barrels a day, is likely to touch 116 million barrels a day by 2030. It is expected to grow at an average annual rate of 1.8 per cent.

It is imperative to relate that global oil production peaked in 2006 which is now falling by 7% per year and that by 2030 world oil production will fall by half. Meanwhile, oil prices have been at an all-time high in recent weeks, touching $100 per barrel. 90% of the worlds oil comes from 44 nations, 24 of which are past their peak in terms of oil production which is now in decline. The current world oil production is around 30 billion barrels per annum while new discovery of oil reserves generates only four billion barrels per year. The demand is calculated to double over the next 20 years.

In the backdrop of this grim scenario economy of Pakistan is experiencing a bad patch of time due to worsening current account deficit triggered by many factors and aggravated by sudden oil price hike. Year 2007 ended up with a current account deficit of over $ 7 billion or 41 per cent more than the current account deficit of the preceding year which was 4.90 billion dollars. It is being feared that current fiscal year may close with a deficit of over $ 9 billion destabilizing the entire financial structure. The global instability and situation in Iran might destabilize Pakistan's economy by increasing the international price of oil to unknown heights, and by disrupting Pakistan's prospects of enhanced economic and commercial ties with its western neighbors.

The immediate reason reported for accelerated prices are the fear of an American attack on Iran to stop its nuclear program. That has been confirmed by President Bush that Iranian nuclear arms would mean World War III. The surge in international oil prices presently seems to have been driven more by market perception of probable supply constraints and growing demand rather than the actual production falling short of current needs. It has raised hopes that a steeper reduction in interest rate would shore up a sagging US economy and raise oil demand in the largest oil consuming country. In case of the US economy slowing down, the Asian economies, critically dependent on exports to the United States, run the risk of achieving a lower than targeted growth.

IMPACTS FOR PAKISTAN ECONOMY:

Pakistan's economy grew at an average of more than 7.5% over the last three years, although it moderated to 6.6% in 2006. The slowdown in 2006 mainly reflected the extraordinary surge in oil prices, the devastation caused by the October 2005 earthquake and adverse weather conditions. Most countries in South Asia felt inflationary pressures in 2006 on the back of high oil prices. Pakistan also fell the victim of circumstances and consumer prices rose to 7.9%, as a result of higher aggregate demand compounded by shortages of principal commodities. In Pakistan, exports and imports continued to grow at double digit rates in 2006. The trade deficit widened to a record $8.4 billion in 2006, with 45% of the increase due to a higher import bill for crude oil and petroleum products. As the current account deficit is becoming a serious concern, this will have implications for the balance of payments. If oil prices remain high, there will be need to devise ways to contain the current account deficits.

The upward trend in oil prices does not prefigure a rosy picture for Pakistani consumers or the country's balance of trade. The cost of petroleum products and crude oil accounted for over 24 per cent of the import bill in 2006-07 and a sustained rise in prices, as witnessed in FY06, will spell serious trouble. The State Bank governor has also warned that inflationary pressures may be further generated if fiscal compulsions drive the government to pass through a rise in fuel prices in the face of rising international energy prices. Food inflation has assumed debilitating proportions for the poor masses of the country and is hitting the middle classes hard as well. It is obvious that an increase in local fuel prices is definitely attempting to make goods costlier across the board. This bitter fact further propels the vast majority of the population to the chasm of growing misery. Anything that is transported will be vulnerable to price hikes and that applies to non-food items as well. As almost all utilities of life inevitably get moved from far and wide there will be far reaching implications and inflation rate will experience unknown heights. If energy becomes costlier, the cost of production will go up, adversely impacting both domestic consumers and exporters whose products could be rendered even less competitive than they are at present.

With international crude prices ready to breach the $100 a barrel mark, Pakistan which imports more than 80 % of its oil faces enormous challenges. With the economy growing at over 7% demand for oil is soaring. And while the government is reluctant to raise the price of petroleum products, for fear of alienating voters, consumers still don't feel the pinch and are recklessly wasting energy.

Pakistan may feel the bitter fallout of $100 a barrel as world price of oil sooner than feared earlier. The reality of such a giddy price for oil is staring us in the face today. Earlier the $100 a barrel was expected by the middle of next year but now this has become a reality within the short span of two months. Higher than anticipated international oil prices due to significant interruption of supply also are an important risk for the country. Higher prices have a direct impact for inflation, the current account deficit and the government balance because of increased government spending on fuel subsidies. At the same time reduced exports due to slower global growth has weakened government revenues and export earnings, thereby exacerbating direct impacts on government and current account deficit. A simultaneous rise in both fiscal and current account imbalances could undermine the perceived creditworthiness of country in the region resulting in significantly higher interest rates that could undermine growth prospects.

Government has to intervene before the whole economy reaches at the brink of devastation by dint of any further rise in prices. Certain initiatives are to be taken to ensure the absorption of upsurge in prices and minimizing the transfer of adversities to the poor masses of society. In the short term, the initiatives that were announced in 2005, and again in 2006, to promote the production of petrol with a ten per cent ethanol mix should be taken to their logical conclusion. The sugar mills already have the required infrastructure in place and the petroleum lobby must not be allowed to derail. Refined petroleum products have been capped at unrealistically low levels in Pakistan and most people do not feel the need to conserve energy by opting for car-pooling or avoiding unnecessary journeys. The result: even as consumers, auto manufacturers, and governments in the west are coming out with innovative measures to reduce the dependence on oil, in Pakistan nobody except the oil marketing companies are worried about the prospects of $100-plus a barrel of crude and its impact on long-term energy usage.

GLOBAL PERSPECTIVE:

Global oil prices are continuously soaring in the backlash of a weakening dollar and speculative trading fuelled in part by the political premiums" associated with geopolitical uncertainty in the Gulf. With the dollar hitting all-time lows against the euro with almost every passing day, oil producers are naturally looking to keep real earnings and USD forex reserves stable through higher prices. The seemingly insoluble crisis in Iraq and Washington's increasingly shrill anti-Iran rhetoric also factor into the equation. At the same time, production in Alaska has been falling, leading to a decline in US reserves. With winter and its peak demand just round the corner, confirmation of a steep drop in American inventories sent US oil prices jumping to a record high of over $94 dollars a barrel on Thursday while London Brent closed at $90.46. It now seems that earlier predictions of oil prices crossing the $100 mark by year-end or in early 2008 may not be off the mark. Whether Opec's commitment to raise production by 500,000 barrels a day from Nov 1 will help stabilize prices remains to be seen that is if the promise actually materializes.

Last week, the Paris-based International Energy Agency (IEA) warned that India, along with China, would be responsible for the soaring global energy needs. The two Asian giants growing at a hefty pace of nine per cent and 12 per cent respectively are projected to account for half the growth in energy demand over the next 25 years.

The bottom line of the story is that the war in Iraq and Afghanistan in fact is a fight for the last traces of oil and gas left on earth. Former chairman of the US Federal Reserve had already delineated that fact and is further conceded by the report of the Germany-based Energy Watch Group to convince the world that .

PROBABLE RISKS :

Normally, when the world economic situation is not bright and oil consumption is reduced, oil prices don't go up but not this time when the western world is facing a credit crunch following a crisis in the US property market. The International Monetary Fund's new forecast says that economic growth in the world will be 4.8 per cent in 2008 while it will be 5.2 percent in 2007. So a combination of a threat of another war in the Middle East, shortage of the US oil reserve and the eagerness of the oil producers to get more bucks for their oil are pushing up the oil price.

Russia and the Caspian countries have together warned the US against attacking Iran but whether that will restrain the US remains to be seen. The Asian Development Bank says that Asia is the fastest developing region. That means Asia will consume far more oil but will be handicapped by the far higher price of oil. However, one part of Asia-the Middle East- will gain by the higher prices of oil surplus money which is sought to be invested but the oil poor countries like Pakistan and India will suffer.

Pakistan which produces only 20 per cent of the oil it uses will truly suffer. Last year, the OGDC was expected to drill 100 oil and gas wells but succeeded in drilling only 50. It had no success with its offshore ventures either. Although more and offshore wells are being drilled more local companies are joining the foreign explorers. Higher price of oil touching $100 a barrel will hit domestic economy hard. But the government which earned over Rs176 billion from oil and gas may earn more while the country will suffer. Power production will become far more costly as furnace oil prices shoot up. Industrial production will cost far more.

Transportation costs will rise. Railway fares will go up and airlines will raise their fares substantially. As transportation costs rise, bus fares will shoot up and bitter disputes between passengers and the bus conductors will become common. In the farm sector, the power rate for tube wells will go up making farm output far more costly. Higher power rates will affect the service sector including hotels, restaurants and shops. Power for schools , colleges and universities will cost far more.

The government sells the oil it drills within the country at international prices. So the cost of production will go all round . Overall the cost of living will rise substantially, particularly if the POL prices are raised substantially.

The "upside" to rising oil prices is that it could, conceivably, translate into a heightened search for alternate energy sources. In the case of Pakistan, a country with a long coastline and an agro-based economy, we ideally would do well to concentrate on wind and biomass power. At the same time, efforts to harness coal deposits said to be second only to those of the US ought to be accelerated but with an unwavering eye on using the cleaner technology developed in Europe rather than being saddled with second-hand, pollution-heavy American plants. All this will take time. However it is notable that Pakistan has little likelihood of developing the diverse and broad based alternative energy resources at present. Therefore in case of any foreseen global dispute the country will run the risk of depletion or acute shortage of energy resources at all. The cruel irony is that most alternative systems of energy solar panels, windmills, hydrogen cells, bio-diesel, nuclear plants rely on technology using oil. All electrical devices make use of silver, copper and platinum, which in turn need oil for their discovery, extraction and transportation. The manufacture of all machinery needs oil. Nuclear energy requires uranium, which is discovered, extracted, and transported using oil-powered machinery.

Hydrogen could be another abundant source of energy, but the cost of hydrogen fuel cells is astronomical. One cell costing a million dollars supplies energy to drive a car for one year only. Hydrogen cells are made from platinum. Even to produce platinum, oil is required. This option being highly expensive and unaffordable is remotest for poor countries like Pakistan to adopt. Bio-fuels like ethanol and bio-diesel are also possible but there is hardly enough arable land for growing the crops to meet the enormous demand. Pakistan is already running out of arable land on which to grow food. It takes 11 acres to grow enough corn to fuel one automobile with ethanol for about a year's driving.

OPEC :

At this point of time, OPEC which has over one-third of the global oil market share, does not seem to have been prodded into action either by the sudden price spurt or by the alarming forecasts that oil would hit over $100 by end of 2007 and $120 in the first half of 2008. OPEC blames refining shortage, geopolitical instability and speculation in futures for the situation. It does not seem inclined to raise its output beyond 50,000 barrels per day from Nov 1 as it had promised earlier. Instead of keeping the demand and supply almost balanced, the oil exporters must boost production to prevent a price spiral. The two trillion dollar oil trade is one of most strongly entrenched international businesses as the efforts to find oil efficient technologies and alternative renewable sources of energy have only just started bearing fruit. The new energy products have become competitive due to the quadrupling of oil prices since 2002. Till such time that these energy products gather critical mass, the oil market may not be disciplinedCONCLUSION:

The recent sharp rise in oil prices has created concerns about their impact on all countries, high and low income, both net oil importers and oil exporters. Estimates of the likely effects on world Gross Domestic Product (GDP) and on the GDP of specific groups of countries have been made by several organizations, including the World Bank, as well as the International Energy Agency. Of particular concern for agencies concerned with development and the Millennium Development Goals is the impact on the poor.

In Pakistan the inflation is high and food inflation is even higher. In order to curtail the downside effects of this issue the government should do not plunge into short term remedies as raising prices abnormally to mitigate the upcoming risks. Instead it should step up its effort for a peaceful settlement between Iran and the US. That will be helpful to Pakistan and the Middle East in many ways. Although it can be an strenuous job. But as we are living in a very uncertain world facing political threats and economic challenges, so we have to behave very prudently instead of running a large trade deficit as well as an external payments deficit.

Simultaneously it is also observed that political convulsions are interfering with production and export schedules. The government politicians have to consider the ramifications any adversities in the economy which affect the poor people instead of relegating the economy to a lower order of things. Their public demonstrations should be more orderly and disciplined, particularly when terrorists are out to wreck the political system.

But in the immediate context, the global economic imbalance created by the unprecedented oil price hike needs to be addressed. While the oil exporting countries are accumulating hundreds of billions of dollars in trade surplus, the oil importers especially the developing countries suffer from huge current account deficits. While an estimated $500 billion dollars of the oil money has been invested in financial markets in the UK and the USA to help them tide over their trade deficits, the developing countries that are worse affected have not received adequate support in the form of massive investments from oil exporting countries. These countries also deserve a much fairer deal and more so from the oil business.