THE IMPACT OF RISING OIL PRICES ON THE ECONOMY
AQEEL AHMED KHAN
BOSICAR PAKISTAN LIMITED
Dec 03 - 09, 2007
The world crude oil prices have maintained their upward trend, reaching their all time highs. The prices of Brent and WTI - the leading benchmark crude oils have touched $99 per barrel. There are many factors leading to present price hikes but this can be mainly attributed to growth in demand by rapidly developing economies of China and India and concerns over supply in future. Disputes over Iranís nuclear programme and delay in restoration of peace in Iraq after the war have further aggravated the situation. The bullish sentiment in the world energy markets has led to increase in activities of hedge funds in the futures markets which has played a significant role in pushing the prices over the fundamentals.
In the last few years, unexpected high demand for products led to a sudden reduction in the spare refining capacity worldwide pushing the product prices upward and then increasing the crude oil prices. The crude oil prices still lagged, reflecting the high refining margins in the recent past.
PRICES OF PETROLEUM PRODUCTS IN PAKISTAN
Pakistanís downstream oil sector has traditionally been regulated by the government whereby the government used to managed the imports, refining, distribution, and pricing of petroleum products. In order to bring efficiencies in the process, government has been working on phased deregulation of the downstream oil industry. A number of steps were taken in this regard but the process has been affected by the rising oil prices.
Prior to July 2001, the prices were reviewed and notified by the Directorate General of Oil under the Petroleum Products (Development Surcharge) Ordinance 1961. In pursuance of government policy of deregulation, the Oil Companies Advisory Committee was authorized to review, fix and announce the prices of petroleum products in accordance with the approved pricing formula with effect from July 1, 2001. The OCAC was under tremendous pressure from the public and media over the increasing oil prices. Later on price fixation powers were handed over to Oil & Gas Regulatory Authority from April 1, 2006.
The rising trend in the oil prices came to halt in end of year 2006 and the prime minister approved to pass on the benefit of reduction in oil prices to common man. OGRA revised the prices downward on January 16, 2007 which are unchanged since then.
Oil continued its journey towards all time highs and government once again decided to protect the consumers from the impact of higher prices and capped the retail prices. Now the deficit has reached to about 50% at the current price levels and government is taking a hit of over Rs. 12 bn per month by subsidizing the oil prices. The oil marketing companies and refineries continue to absorb the substantial impact of high oil prices through Price Differential Claim. The PDC mechanism has put the oil industry into liquidity crisis where the GOP owes over Rs. 44 bn to the oil industry.
The government is expected to increase the prices of petroleum products in December 2007 which is bound to push the inflation and affect economic growth.
IMPACT OF HIGHER OIL PRICES ON THE ECONOMY
Oil prices remain an important determinant of the economic performance. The magnitude of oil price increase depends on the share of the cost of oil in national income, the degree of dependence on imported oil and the ability of end users to reduce their consumption and switch away from oil. It also depends on the extent of increase in gas price in response to the oil price increase and the impact of higher prices on other forms of energy compared to oil and/or produced from oil and gas. The economic impact would directly depend upon magnitude of price increase and duration for which the price increase is sustained.
In a net oil importing country, an increase in oil price leads to inflation, increased input costs and reduced non oil demand. It changes the balance of trade between countries and exchange rates, deteriorates the balance of payments, increases budget deficit and puts downward pressure on exchange rates. Imports become more expensive and exports less valuable leading to reduction in real national income.
The economic and energy policy response to a combination of higher inflation, lower exchange rates and lower real output also affects the overall impact on the economy over long term. Government policies can minimize the adverse impact on the economy but cannot eliminate it. The fiscal policies based on subsidies may simply delay the fall in real income and tighten the inflationary pressures on immediate terms, however worsen the impacts in the long run.
Rising oil prices are a major concern for all the developing economies and Pakistan is no exception to it. It has made far-reaching affects on Pakistanís economy and consumption patterns. Use of CNG is increasing in the transport sector and major industries. Power generation units are also shifting to natural gas from expensive fuel oil.
According to global projections, the oil demand is expected to hit 98 million barrels per day in 2015 and 118 million barrels per day in 2030. It is believed that the era of availability of cheap oil may have ended because of the rising world energy demand. The price has the tendency to increase further till the demand growth is curbed and new technologies are introduced which reduce dependency on oil.