SPILLOVER COST OF POLITICAL RISK PREMIUM IN OIL PRICES
SYED ALAMDAR ALI,
Hailey College of Banking & Finance Lahore
Mar 31 - Apr 06, 2008
The price of standard crude oil on NYMEX was under $25/barrel in September 2003, and with inflation adjustments had remained below this mark since the mid 1980s. A series of events led the price to reach over $60 by August 11, 2005, surpass $75 in the summer of 2006, fall to between $50 and $60/barrel in the early part of 2007, then rise steeply reaching $92/barrel by October 2007 and $99.29/barrel for December futures in New York on November 21, 2007. Throughout the beginning of 2008, oil hit several new record highs. On February 29, 2008, oil prices hit an inflation-adjusted all-time peak at $103.05 per barrel, and reached $110.20 on March 12, 2008, the sixth record high in seven trading days.
According to a report in New York Times by Hiroke Masuike, unlike past oil shocks, which were caused by sudden interruptions in exports from the Middle East, this time prices have been raising steadily as demand for gasoline grows in developed countries, as hundreds of millions of Chinese and Indians climb out of poverty and as other developing economies grow at a sizzling pace. "This is the world's first demand-led energy shock," said Lawrence Goldstein, an economist at the Energy Policy Research Foundation of Washington.
At the root of the stunning rise in the price of oil, up 56 percent this year and 365 percent in a decade, is a positive development: an unprecedented boom in the world economy. But as prices rise, the global economy is entering uncharted territory. The increase so far does not appear to be hurting economic growth, but many economists wonder how long that will last. "These prices are too high and will end up hurting everybody, producers and consumers alike," said Fatih Birol, chief economist at the International Energy Agency.
More than any other country, China represents the scope of that challenge. As it turned into a global economic behemoth over the last decade, China also became a major energy user. Its economy has grown at a furious pace of about 10 percent a year since the 1990s, lifting nearly 300 million people out of poverty. But rapid industrialization has come at a price: oil demand has more than tripled since 1980, turning a country that was once self-sufficient into a net oil importer. Although today, China consumes only a third as much oil as the United States, which burns a quarter of the world's oil each day. By 2030, India and China together will import as much oil as the United States and Japan do today.
Although the current raises in oil prices have been attributed to excess demand, the political scenario in the changing world environment and current US stance of War on terror have also shown their effects in this regard. The international markets have also started to charge some political risk premium which according to an estimate ranges between 25$ to 50$ /barrel. The masses living in the developed countries of the world having adequate per capita income and properly functioning welfare state concepts have automatically been provided shields to cater to this situation. Consequently, the prime effected persons have been proven to be the masses of the underdeveloped countries. Such an effect that has been imposed by the excessive demand of one group of people and on another group of people has been termed as the spillover impact of oil price. No measurement scale has been developed so far that can quantify such spill over cost objectively, neither the developed nations are ready to compensate the developing countries for it.
What would be the solution to this? Is there any slow-down expected in the growing world economies? Is there any change expected in International policies of war against terror? Is there any expectation that the oil producing countries will raise the level of their production? What would be the role of United Nation if this entire oil dilemma turns out to be the responsibility of a few stubborn Nations who want to promote their interests? Well, all these questions seem very much premature at present and will be answered by the time itself!