A barrel of woes
By Shahid Javed Burki
I should have used a longer title for this article and called it "A barrel
of woes and a tank full of worries". The reason is that the subject I will
cover today is not just what is happening to the world oil markets and how that
would impact the global economy and the economy of a country such as Pakistan
that depends so much on the availability of imported oil at an affordable price.
Sultan Ahmad, my columnist-colleague, alerted his readers on October 21 of
the likely consequences for Pakistan if the price of oil remains at the record
levels it touched in the past several weeks in the international markets. He
is correctly worried about the negative impact of this unhappy development not
only on the rate of inflation in the country but also on the rate of growth
of GDP.
He was concerned that the recent pick-up in economic growth might be stalled
if the high price of oil is allowed to dampen investment and consumption. There
is a worry that the poor will be hurt since the present price policy does not
protect them against a sharp increase in the cost of imported fuel.
But not letting the domestic price of imported fuel move with international
price would not be the right policy to adopt to cushion the impact on the economy.
Such an approach would only create a large fiscal burden and postpone the adjustment
the economy needs to make to some time in the future.
The right approach would be to adopt policies aimed at the way the economy
uses energy in order to direct it towards the sectors that have the largest
social impact. I will return to this point a little later. For the moment, let
me go back to the international oil markets and discuss how their recent performance
is likely to influence the global economy.
On October 15, the price of a barrel of oil crossed $55. This was a record
in nominal terms; in real terms, the price adjusted for inflation, was still
below the level it reached after the "second oil shock" delivered
by the Opec in the late 1970s. In spite of the sharp increase in oil prices
in the last several months, the record established in 1981 has not been beaten.
In other words, the impact of this increase on the global economy may not be
as severe as it was a quarter of a century ago.
This is particularly the case for rich economies that now use a smaller amount
of oil for every unit of domestic output they produce. The main difference this
time around is that high oil prices are here to stay for some time to come.
The global economy made a number of adjustments to high oil prices the last
time they increased. This was possible since there was a great deal of waste
in the way energy was used in rich countries, particularly in the United States.
Over the last two and half decades, the pattern of global consumption changed
in significant ways. While consumption as a proportion of GDP has declined in
industrial countries, this has not happened in the developing world. China -
and to some extent India - have become major consumers of hydrocarbons.
The unrelenting demand in China for energy will continue to create pressures
on global demand that will not abate in the foreseeable future since the consumption
per head of the population in that country is still considerably below the average
in rich countries. If India's growth rate also picks up there will be a further
upward push on prices.
The immediate impact on the global economy of high oil prices, however, will
be via the American economy. This, in turn, will be the result of consumer behaviour.
The American consumers have accepted for now the prevailing view in the market
that the current hike in oil prices is the result of shocks that will work through
the system without influencing long-term trends.
It is believed that exceptionally severe hurricane season in the Gulf of Mexico
and the states in that region - a region that is a major source of supply for
the United States and also the location of a significant amount of refining
capacity - created shortages that will be temporary and, therefore, will not
have a long-term impact.
Accepting this interpretation, households in America have gone back to the
stores and retail sales increased by 1.5 per cent in September. These were fuelled
in part by a significant increase in automobile purchases, an item whose demand
for obvious reasons is influenced by the price of oil. The consumers were convinced
that the increase in the price of petrol was a passing phenomenon and would
not leave a lasting impact on their pocket books.
However, if price rises persist - even if they remain close to the present
levels - consumer sentiment may change suddenly. If that happens, the US economy
would be badly hurt since it depends on consumption as the main driver of growth.
This, however, is not the only negative consequence on the American economy
of high oil prices. The country's exports will also be hurt as the purchasing
power of those who buy American goods and services will decline in order to
accommodate increase in oil prices.
The US has factored an increase in exports in projections of a healthy economic
recovery in the remaining months of 2004 and in 2005. There was an expectation
that the significant drop in the value of the dollar would help to increase
exports and bring a semblance of balance to trade. However, the trade imbalance
widened sharply to $54 billion from $50.5 billion in July.
According to Alan Greenspan, the perennially optimistic chairman of the US
Federal Reserve, the risk for the American and global economies "of more
serious negative consequences would intensify if oil prices moved materially
higher". He went on to assert that such a move seemed unlikely although
the world will have "to live with the uncertainties in the oil markets
for some time to come." What is likely to happen is that oil prices will
fluctuate wildly as perceptions continue to change significantly about long-term
global demand and it is this aspect of the oil markets that is of great concern
to countries such as Pakistan?
There are now more variables in the oil demand equation than was the case in
the past. Will American consumers scale back their purchases if the economy
shows signs of weakening? Will China be able to constrain the rate of economic
expansion by producing a soft lending? Will the rate of growth of the Indian
economy pick up and reach the level attained in the 1990s? Will the situation
in Iraq stabilize, and will that country join the ranks of major exporters of
oil, as was the hope when the Americans launched their invasion? How will the
political situation evolve in Saudi Arabia and how would that affect that country's
participation in global oil business?
A negative answer to any of these questions will rock the international markets.
The consequences would be really grim if more than one of these variables move
in the wrong direction. The probability of unfavourable developments remains
very high which is the reason why policymakers in Islamabad must brace themselves
for sharp fluctuations in oil prices around a level that will remain high. Also
complicating the global energy picture are some recent developments in the sector
of natural gas.
Natural gas is the fastest-growing source of primary energy in the world, with
global consumption estimated to increase by over two per cent annually through
2025. In the United States, once again the largest consumer of this fuel, consumption
is likely to increase by 40 per cent over the next two decades. Some analysts
believe that a number of changes are occurring in these markets that will have
a profound influence on the supply and long-term price of this important fuel.
Russia, the world's largest producer of natural gas with 28 per cent of known
global reserves, is central to these changes. It is following an approach that
might result in creating an Opec-like cartel for natural gas. Russia would dominate
such an arrangement to a much greater extent than Saudi Arabia has managed to
do in the business of oil.
Moscow has tightened its grip on the suppliers of natural gas in the region
it calls its "near abroad". In April 2003, Gazprom, the Russian gas
giant, concluded a 25-year deal with Turkmenistan to purchase natural gas from
that country. This way it will be responsible for managing the entire export
of gas by that large Central Asian producer.
In June of this year, Presidents Vladimir Putin and Islam Karimov (of Uzbekistan)
signed an agreement that gave Gazprom the right to develop Uzbek gas reserves.
The Russians are also negotiating a deal with Tashkent that could result in
Moscow acquiring a 44 per cent share in Uzbektransgas. Moscow also has an interest
in developing Afghanistan's gas reserves.
What are the various options available to Pakistan to deal with a complicated
and unstable global energy situation? State policy in the sector of energy has
three components - price, supply and demand. On the price and demand sides,
past policies have allowed household consumption to increase at the expense
of consumption by industry and agriculture. While there may be a case for helping
the poor this has to be done with care since subsidies directed at the poor
have a way of being captured by the well to do.
As already indicated, it may be tempting to keep the price of various kinds
of fuels low through state subsidies. Such an approach would do long-term damage
to the economy. Instead, the government should adopt policies that help reduce
fuel consumption while, at the same time, develop alternative sources of supply.
On the supply side, Pakistan can no longer postpone the exploitation of the
only source of energy that is available in abundance - hydel power. Political
disputes among the provinces on the location of storage capacity have caused
expensive delays in the construction of dams at Bhasha and Kalabagh. This must
not be allowed to continue. Also on the supply side is the question of providing
incentives to the private sector to invest in the development of gas and coal
reserves.
Pakistan has a large deposit of coal. To use this for generating electricity
will need to be done in an environmentally friendly way. The Chinese have developed
technologies for the clean burning of coal for producing power. These could
be imported into the country. Still on the supply side is the question of participating
with countries in Central Asia including Afghanistan, with Iran and with states
in the Persian Gulf to bring natural gas not only to Pakistan but also to all
of South Asia.
What is needed, in sum, is a comprehensive energy policy that is economically
viable and politically acceptable to most segments of the society.
[taken from http://www.dawn.com/2004/11/02/op.htm]
Date/Time Page Created: 12/01/2004
Date/Time Last Modified: 12/1/2004 8:30:05 AM
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