LEARNING TO LIVE WITH HIGH AND VOLATILE OIL PRICES

Prices have risen to levels not witnessed in the recent past

By SHABBIR H. KAZMI
 Apr 11 - 17, 2005

The latest hikes in crude oil prices are causing worries in importing countries about the economic cost of higher energy prices. Higher fuel prices are causing higher inflation, restricting economic growth and affecting purchasing power of individuals adversely. Major oil exporters are divided into two groups, one led by Saudi Arabia and Kuwait supporting increase in output in an attempt to ease prices. Whereas the other group led by Venezuela is against conciliatory moves towards big consumers.

According to the International Energy Agency, global economic expansion is the biggest reason behind increase in oil demand, which is at the highest for 24 years. There is higher than expected demand in industrialized countries and China's rapidly expanding economy has created a huge demand boost. According to a BBC report, the oil demand has risen because of strengthening economic recovery and greater need for higher grade crude oil suitable for processing into petrol (gasoline) for the fuel-hungry Sport Utility Vehicles (SUVs) popular with US drivers. Chinese demand is up 20% over the past year. Traders are betting this rapid growth will continue for several years, although there is some chance that the economy will "overheat" and oil demand growth will slacken.

Oil companies have tried to become more efficient in recent years and operate with lower stocks of crude oil. Therefore, there is less of a cushion in the market against supply interruptions. As against this events such as violence in the Middle East, ethnic tension in Nigeria and strikes in Venezuela have had a greater effect on prices in the past year than might have been the case if stock levels were higher.

The Organization of Petroleum Exporting Countries (OPEC) accounts for about half of the world's crude oil exports and attempts to keep prices roughly where it wants them by trimming or lifting supplies to the market. In the past, OPEC tended to wait for prices to dip before agreeing to cut output. As against this, now OPEC is acting more aggressively, announcing production cuts to pre-empt any weakening in prices. International oil companies traditionally used times of seasonally weaker demand, when prices were lower, to rebuild stocks. This option no longer seems to be available.

The combination of OPEC's strategy and low stocks leave the market exposed to the prospect of sudden price rises if supplies are threatened. This has not gone unnoticed by professional market speculators. Hedge funds and other speculators betting on the possibility of higher prices have themselves exacerbated price pressure in the market. OPEC officials tend to blame speculators for 2004's run-up in prices, ignoring the organization's earlier role in preventing stock rebuilding. OPEC argues that its members are now pumping flat-out which is largely true and that it is powerless in a situation where factors other than mere supply and demand are at work.

The world's major oil consumers remain dependent on the Middle East for their oil. Recent violence in Iraq and Saudi Arabia has again raised fears about interruption in supplies. Iraqi exports have been cut due to attacks on oil facilities. The reduction in supplies has been relatively modest but it has caused some doubts about Iraq's longer term prospects of becoming a large and stable oil exporter. Attacks on foreign workers in Saudi Arabia have also increased uneasiness. Any substantial attack on Saudi oil facilities would be a major event for world oil markets. The country is the world's biggest oil producer and, by far, the biggest exporter.

Analysts are also of the view that political unrest in non-Middle East states like Nigeria and Venezuela also has the potential to disrupt exports and drive oil prices higher. There have been concerns that a dispute between Russia's government and the country's biggest oil company, Yukos, could lead to the shutdown of a good deal of Russia's production. Yukos pumps one fifth of Russia's approximate 8.5 million barrel a day output but faces bankruptcy and/or dismantling over huge government demands for taxes.

OUTLOOK

According to some latest reports, crude oil prices may touch as high as US$ 100 per barrel in the future, only because demand is exceeding supplies. In such a scenario the worst hit countries will be those which are heavily dependent on oil and Pakistan is no exception. Higher oil price is causing cost-pushed inflation and adversely affecting purchasing power of people.

Though, Pakistan is rich in coal reserves, its use as fuel has not become a norm. The effort to use gas for power generation is also acting as double-edged sword. On the one hand gas reserves are depleting at a faster pace, on the other hand, rise in feedstock price has put a cap on addition of new urea production capacity. The persistent increase in urea price could also adversely affect yield of food and cash crops.