Oil price hike to retard economic recovery
By Shahid Javed Burki
Monday, 14 March, 2011
THE global economy — and that means not just the economies of the developed world but also of developing countries such as that of Pakistan — are going through another ‘black swan’ moment. The term was coined by Nassim Taleb to describe the impact on the economic systems of what are very low probability events.
He claimed that most economic thinking and most financial models are based on the assumption that the past will define the present and the future. That may be the case most of the time but not all the time. In fact, it is the unexpected that has more to do with the way economic systems move than normal occurrences.
The latest “black swan moment” is related to the unfolding revolution in the Middle East. Not even the most astute observer of politics of the area had imagined that the Arab streets would explode the way they did; that two well-established regimes would collapse within days of feeling the pressure from the streets, and that a third country would see a civil war between the defenders and opponents of a regime that had lasted for more than four decades.
If these developments had occurred in some other parts of the world, they may not have been noticed with as much interest. But in the case of the Middle East, with the world’s dependence on imported oil of which the region had a great deal of spare, the political upheaval had far-reaching consequences.
Once it became clear that the political change in Libya will not be as fast as those that took place in neighbouring Tunisia and Egypt, the world oil markets became nervous. Although Libyan exports account for only two per cent of the oil traded in international markets and although disruption in supplies affected one-half of Libya’s exports, the market reacted with near-panic. On Monday, March 7, the US oil prices increased to their highest levels since September 2008, trading at an intraday high of $106.95 a barrel, as Brent, the European benchmark, hit a session high of $118.50.
Gold jumped to a record of $1,444 an ounce. Stock markets in both developed and developing countries came under pressure. Any prolonged downturn in their values would dampen consumer confidence.Vix index is one indicator of the way the markets were looking at the situation. Often called “Wall Street’s fear gauge”, it rose by eight per cent on March 7, one of the sharpest increases in recent times.
These increases were bad news for most parts of the global economy. If they persisted they would reduce the pace of recovery from the Great Recession of 2008-09 and seriously hurt countries such as Pakistan that were not only dependent on imported oil but were still struggling with serious economic downturns. Even though experts pointed out that the disruption in supply was minimal, and that there was enough capacity in the oil exporting countries to meet the shortfalls that had originated in Libya, the market sentiment remained jittery.
Oil price depends not only on the balance between demand and supply. As became evident in 2008 during the previous period of price escalation, speculators played an important role in the market. They were back in play. There was speculation that the situation in Libya will get much worse before it stabil ises. The turmoil could reach Saudi Arabia and were that to happen, not only will the price go through the roof but would also produce a severe global economic downturn, deeper than the one from which the world had only just begun to recover. Nouriel Roubini, an economist who had predicted the global financial crisis said that an increase in price to $140 a barrel will cause some advanced economies to slide back into recession.
Of the options that were available to the global community, one was already in place and the other was being talked about. The first was to have the countries with the capacity to increase their output to step in and increase their supplies. The second was for the United States to tap its strategic reserves. Opec which controls about 40 per cent of global oil supplies was divided about its response to the crisis. While Saudi Arabia, Kuwait and Nigeria were ready to increase their output, Iran and Algeria were of the view that such a response was not required.
Nonetheless, industry’s officials said the production increase ex pected by early April including the increase already announced by Saudi Arabia would make up the shortfall in supply expected to occur in Libyan oil exports. Riyadh had already increased its pumping by 700,000 barrels a day while the Kuwaitis and the Nigerians were working on increasing their output by 300,000. The two together would provide an additional one million barrels a day which was equal to the decline in Libyan exports.
The other option to take out some excitement from the oil market was for the United States to tap its Strategic Oil Reserve which holds 727 million barrels of oil in the depleted salt mines in Texas and Louisiana. These reserves were created in response to the 1973 oil embargo imposed by the Arab oil producers but have not been used to stabilise prices. Several analysts believe that even a hint that the reserves could be used would take the panic out of the markets.
One consequence of the increase in oil price is to significantly enhance the economic power and standing of Russia, now the largest producer of oil in the world. The country does not keep any spare capacity – that would be difficult to do in the extreme cold in which its wells are located. Combining gas with oil, Russia is by far the largest energy exporter in the world. According to one analyst, “Russia is not only outside Opec, and thus free from cartel’s restraints but also, with its formidable secret policy apparatus and population bulge among the elderly rather than the young, is seen as less vulnerable to an outbreak in social unrest.” Moscow has been able to exploit this advantage and has succeeded in inviting large investments by foreign energy companie--- $4 billion by the French firm Total and $7.8 billion by BP. It is also working on building two gas pipelines that will carry its gas under the sea to points of consumption in Western Europe. And, after three years it has begun to add to the accumulated $50 billion in its sovereign wealth fund. It would not be inaccurate to suggest that the Middle East’s loss is Russia’s great economic and strategic gain.
Among the many different ways in which the turmoil in the Middle East is likely to affect the global and economic landscapes, one that is of immediate consequence is the turbulence in the oil market.The affect of this on Pakistan will be severe, a possible repeat of the balance of payments crisis of 2008.