Interesting Read:Dr. Neville Bennett
n.bennett@hist.canterbury.ac.nz
September 12, 2000
Oil
Relief that OPEC has increased oil production may be premature. Further price increases are likely.There is a particular shortage of refined products, especially heating oil. An analysis of the oil market, factors of supply and demand, and pricing procedures in fact raises the question if this is similar to the 1973 scenario, when rising oil prices brought inflation and recession.
OPEC has agreed to boost output by only 3.2%, which is a minimal gesture in light of the failure of its two latest attempts to decrease prices. Prices have increased by 31% since its April 1 production boost. No doubt some suppliers would like to see greater output (though few have spare capacity) because a high price is counter-productive: it curbs demand, encourages substitution by competitive fuels (e.g. gas) or more efficient technologies.
It is moot point how far OPEC is responsible for oil prices. It controls only 44% of production and cannot influence other producers; they quietly cash in on their opportunity. The earlier success ascribed to OPEC is also somewhat dubious, for the price rises of 1973 owed much to the Arab-Israeli War and the 1980 rise owed much to the Iraqi-Iran War and the Iranian revolution.
Moreover crude oil, which is the commodity that OPEC provides, is not the main bottleneck. If it were, OPEC could remedy all problems by increasing delivery of more crude, and it takes only three weeks to transport oil from the Gulf. The real problem is the supply of refined products (heating oil, aviation fuel etc) Prices are high simply because the refineries are running at full capacity and are still unable to build up stocks. Indeed American stocks are at there lowest for 24 years. The key problem is that the oil companies have under-estimated demand which is driven by the booming economic growth of the USA, and strong recovery in Europe and Asia. As winter is approaching in the Northern Hemisphere, an element of panic is entering the calculation of short-term needs, and this is exciting the market.
Crude oil is the world's most actively traded commodity, centering on markets in London, New York, and Singapore. Typically these deal in futures contracts for forward delivery in one month. With a minimum contract for 1000 barrels, buyers typically deal with sellers to arrange delivery of a precise amount of oil at a pre-arranged price at a designated location.
As there are many varieties of oil (differing in thickness, amount of sulphur etc) traders refer to benchmark crudes. Other varieties are then priced at a discount or premium to the benchmark. Brent (North Sea) oil is used as a benchmark in two-thirds of global trades (although Saudi Arabia alone is a larger producer). US sales are benchmarked in West Texas Intermediate.
Thus the market price of crude oil is increasing because there is mounting anxiety about supply in the coming winter. There is a perceived shortage because of demand from strongly growing economies, and a failure of the refining industry to anticipate needs. There is a distinct possibility of oil spiking above $40 especially if the northern winter is severe.
What will be the consequences of the oil price rise? Some effects are apparent already. The inflationary effect is obvious, especially in areas also affected by depreciating currencies. Central banks are responding with increased interest rates. Generally, the effect is similar to a tax increase; it cuts discretionary spending and curbs economic growth.
While gradually stimulating a general price rise, an increase in oil prices has severe impacts on some economies and particularly some exposed sectors. Recent protests by truckies and cab drivers illustrate the immediate impact on transportation. But aviation will also suffer with follow-up effects on tourism and trade in fresh preciosities: fresh flowers, lobster, prawn, tuna, asparagus, cherry, and strawberry. Heating, air-conditioning, and power generation may be reduced. Industrial costs for heating, drying, baking, brewing, painting, smelting, mining will increase, as will costs in agriculture and fishing. There will be large increases in the cost of many chemicals, fertilizers and plastics. The auto industry already had reduced sales, and its associated trades will follow.
Among countries there will be winners and losers. Although the French have been noxiously noisy about prices, the rich tend to be winners, or lose very little while the poorer nations will suffer, unless like Saudi, Russia or Mexico they produce oil. The biggest losers are Thailand and South Korea.
Richer nations have diminished their oil dependency by encouraging other fuels or energy sources, promoting fuel efficiency, and developing new technology (hydrogen is very promising). Perhaps more importantly, the rich have moved massively out of manufacturing, especially the energy- intensive and polluting ones such as metal refining, plating, smelting, steel, and ship-building.
These industries have been relocated in the poorer nations, whose energy dependence has increased because of increased manufacturing and distribution, and wider car ownership. Consumers spent 10% of their income on oil products in the 1970's: they now average 4.3%. European oil expenditure is exaggerated of course by tax impositions designed to raise revenue and ensure that the polluter pays.
Even the richer countries may not prove to be invulnerable to an oil shock if prices attain $40 for a length of time. For one thing, world growth has been considerable assisted in the mid-1990's by extremely low oil prices, which lowered production costs and thereby were non-inflationary. A tripling of prices in two years must set up strains.
The OECD calculates that a $10 increase in the price of crude oil, sustained over one year, lifts inflation by 0.5% and slows growth by 0.25% in rich countries. I assume the impact is considerably greater in other countries where oil consumption is rising because of rapid industrialization and escalating rates of car ownership.
Inflation and wages feed upon each other. Oil-price induced cost of living price increases will trigger wage demands, which if granted, will stimulate more inflation. The European Central Bank has already raised interest rates to check inflation, while the US Fed has not, thereby risking, The Economist says, higher rates and a sharper downturn next year.
The present dearth of comment upon the adverse effects of the oil hike is reminiscent of 1990 when OPEC also raised prices. Most agencies were unfazed predicting nearly 3% global growth. Growth fell in 1991 to 0.8%, and some economies went into recession. The year 2000 price rise is accompanied by other adverse features, notably volatile capital movements and a surging US dollar which have magnified the damage dealt to such vulnerable economies as Thailand, South Africa, and New Zealand.
This year's oil problem may yet become a crisis, especially for New Zealand, most of Africa, most of Asia and most of Latin America; economies which are doubly discomforted by devaluation's, surging import costs, burgeoning debts and a magnified oil price increase. As the global economy is one, their plight will affect the more fortunate economies, through depressed markets and difficulty in loan servicing to say the least. Global growth will suffer.
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