Business Page   Cheap oil is dead

Sunday, September 18th, 2005

 

Introduction:

Despite facing its fourth oil shock in just over thirty years, the world seems unprepared and indeed shocked that oil prices can behave in such an irrational manner. After all was the world not thinking just a few years ago that oil prices would collapse and that a price of US$10 per barrel was a real possibility? How does one explain then the rise to close to US$70 per barrel and what are the chances of oil reverting to anything like a normal level over the foreseeable? In this article we will try to unravel the complex factors that play havoc with the oil price and perhaps disappoint readers with the view that 'normal' does not mean any significant reversal in the prevailing high price. In fact poor and developing countries like Guyana should stop thinking of high and low oil price but rather about affordable oil and its effect on our economy and society.

The optimists which in-clude our own Prime Ministerlike to point out that in every one of the three oil crises since 1973 (measured by dramatic changes in the price), pre-shock levels soon returned and the world and Guyana went about its merry way of irresponsible use of such a precious resource that many believe are running out much faster than we can find new sources. I do not share such optimism. I believe that this crisis is worse than any we have ever experienced, that it is different for those that have gone before and that the current price levels will not reduce significantly.

Supply shock:

There is a fundamental difference between the present crisis and those that have gone before. The first shock in 1973/74 was caused by the embargo placed by the Organisation of Petroleum Exporting Countries (OPEC). The second (1978/80) was caused by the Iranian Revolution and the overthrow of its Shah and his replacement by Ayahtollah Khomeni who was as great an enemy of the United States as the Shah was a friend.

The third (1989/90) was caused by the first Gulf War sparked by Iraq's invasion of Kuwait and the decision by the US and 'coalition forces' to respond to Saddam Hussein's aggression against its neighbour who just happened to be close to the US, which incidentally alone consumes one-quarter of the world's oil.

Each of these events had a swift and adverse effect on the world's economy with global recession in every case. Because each of these events represented a supply causation, it was not surprising that the end of the embargo or hostilities brought supply and therefore price back into balance.

Even in the current situation there have been some supply disruptions including the war in Iraq and at least for a short while unrest in Venezuela and more recently the ravages of Hurricane Katrina on the refining facilities in the Gulf Coast of the United States. But the current price escalation is largely demand driven with China and India requiring increasing amounts of oil to fuel an expanding economy and a growing middle class. It was with understandable relief that where the shock was supply driven, prices eased as soon as the problems came to an end.

With both China and India showing no signs of slowing, two things are likely to take place - one good and the other less so. As demand continues, prices will remain far above $60 when only a short while ago US$50 was regarded as a psychological benchmark. The other is that we are unlikely to see a major decline in world economic growth partly of course due to continued growth in those countries like China, Brazil, India and South Korea.

Cheap money:

Economists used to say that for every US$10 increase in the price of oil, world's GDP would decline by around 0.6 per cent. By this measure world GDP since 2001 should have fallen close to zero. With this not happening, economists have had to look around for the reasons. That reason is largely found in the low levels of inflation being enjoyed around the world. In the US, the world's largest economy, low inflation has kept interest rates in check despite that country being among the least thrifty nation in terms of the amount of earnings put aside by its citizens as savings. Low interest rates have caused a spending and housing boom in the USA described by some as a bubble which scares the more cautious since as night follows day, burst always follows bubble.

The possibility of an economic meltdown in the US does not appear on the horizon and even the oil-exporting countries that are benefiting immensely from US$60+ oil price have a vested interest in keeping the US economy going, if only because much of the oil surplus is invested in the US.

In a recent appearance on Plain Talk, the television programme which I host, Prime Minister Sam Hinds who has ministerial responsibility for energy repeated the oft- expressed but inadequately thought-out view that in real terms oil is still fairly cheap, a view that ignores a number of relevant economic variables. The Economist in a recent issue entitled Oiloholics notes that measured in terms of world export prices, oil price is now above the levels of 1974 and 1980. I am neither reassured by the Prime Minister that oil is still cheap in relation to 1973/74 nor feel good to hear President Jagdeo tell the nation that the government "has spent about $2B on to cushion the impact of rising fuel prices on governmental agencies and prices."

Oil impact:

I wrote in a recent Business Page about the accountant's magic in converting the accounting profits submitted to the banks into losses submitted to the GRA but must now say that Jagdeo's basis of his 'G$2B spending' is no less magical. It is unclear whether the President has taken over from the Prime Minister as the spokesman on energy but clearly what we need is not to be confused by fancy figures. What we desperately need is serious consideration of the impact of oil on the economy and the country. We need to consider, for example, the logic and extent of the subsidies given by the government to some entities whose contribution to the economy is still to be openly and honestly assessed.

How oil prices affect an economy obviously depends partly on whether the economy is an oil importing country or an exporting country. But it also depends on a) the more subtle question of the extent to which the economy is a brains and technology one or is an industrial economy heavily reliant on energy; b) the country's pricing and tax policy and c) the extent to which it finds it necessary and desirable to subsidise fuel. America and Europe take contrasting positions on this issue which at its core is really how to ration a scarce commodity.

Europe takes the position that taxation is a better tool, as a result of which fuel in Europe is about US$6 per gallon and conserving on the use of the commodity is taken quite seriously. By contrast the US, partly under pressure from the vehicle industry, prefers to go for fuel-economy regulations which appear not to have been particularly successful, and fuel at the pump is about half the cost at European pumps.

Policy on oil:

No question about it - cheap oil (which includes exemptions and subsidies) leads to waste, does not promote the search for alternatives or new sources of fossil fuel and militates against such practices as public transportation. Of course higher cost of fuel has adverse consequences as well. It feeds into higher business and domestic electricity cost, industry production cost, transportation costs and just about everything else a society needs to function normally.

Oil is an international commodity and the influence which any one country can exert over it is clearly limited. But that does not eliminate the need for every country to have a clear policy not only on oil but on the wider question of energy, with an appropriate balance between affordability and the economic use of oil.

And it is here where the country has truly fallen short. Since the spectacular failure of Mr Burnham's attempt to introduce hydro-electricity several decades ago, neither major party has put much effort into how Guyana should meet its fuel needs in a manner that allows the country to compete internationally. Former Presidents Hoyte and the two Jagans and President Jagdeo have sought the easy way out by emphasizing the search for oil which centuries later may be compared with Ralegh's search for El Dorado. We need to direct our thoughts and ideas beyond oil and to consider the many alternative sources of energy which are readily available.

The country has no energy policy while the economic proposals of all the political parties including the two major parties offer no new ideas on how to deal with the continuing energy crisis. Even the otherwise excellent National Development Strategy which the government has all but abandoned did not adequately address this problem.

In fact as we hope to show next week several of the policies being pursued by the government are counter-productive and should be urgently reversed.

To be continued