When Oil Prices Soar

Developing countries are more adversely affected
than developed ones for several reasons

By XU JIANGUO

HOW ELSE WOULD I GET TO WORK? Gasoline prices in the United States have soared to around $2 per gallon, the highest in its history

The global economy has staggered since the turn of the new century due to recession in Europe and North America, the scare of terrorism and the uncertain consequences of the Iraq war. Since late 2003, however, there have been signs of recovery. According to the latest prediction of the International Monetary Fund (IMF), the growth rate of world economy is expected to reach 4.6 percent in 2004, 0.7 percentage points higher than last year. However, the bright prospect may be overshadowed by the soaring price of oil.

As a resource upon which industrial nations rely, petroleum and its cost have immediate impact on the world economy, as well as indirectly affects international political and economic strategy.

Oil and the World Economy

When oil sells at high market prices, the world’s leading oil consumers, the United States, Japan and the European Union (EU), will confront bigger difficulties in concluding their domestic economic policies. Oil enterprises will face rising production costs and falling revenues. Expensive oil will compel the United States and Japan to increase federal interest rates, while making it harder for the European Central Bank (ECB) to lower its rates to simulate its economy. The U.S. trade imbalance is more severe, peaking at $46 billion last March. Soaring oil prices have contributed to this result.

As for the growing markets in Asia, including China, higher oil prices raise import costs, drive consumer price hikes and increase inflation pressure. According to the estimation of the International Energy Agency, if the price of oil increases by $10 per barrel within a year, the Asian economic growth rate will drop 0.8 percentage points. Sometime this year, China is expected to replace Japan as the world’s second largest oil importer, after the United States. In 2005, China’s oil imports are expected to reach 100 million tons. Since China’s oil purchases are primarily spot transactions, a hike in oil prices will have an exaggerated effect on its economy and people’s consuming habits.

Despite these ill effects, the overall global economic recovery will not be reversed. The current flux of oil prices began in January 2002, yet it did not prevent the economies of the United States, Japan and the EU from pushing ahead since late 2003. A brisk increase of oil prices actually indicates, to some degree, that economic recovery spurs oil demand, though oil production has not been exceeded by demand in the international market. Aside from the impact of a cut in production by the Organization of Petroleum Exporting Countries (OPEC) and the tense situation in the Middle East, it has been the speculations of major international oil companies that have largely contributed to the spike in oil prices.

This will have limited effect on economic growth of the countries that are driven by sectors, such as the hi-tech and service industries. Impact will be severer in newer markets, whose economies rely more on manufacturing and are less dynamic. In fact, economic growth for the least developed countries could fall 2 percentage points. The IMF predicted that the three major economies of the United States, Japan and the EU would enjoy economic growth at 4.6 percent, 3.4 percent and 1.7 percent respectively this year, even if oil price remains at $40 per barrel. Even when the rates drop marginally, from 0.3 to 0.5 percentage points, their growth would still be higher than their respective 3.1 percent, 2.7 percent and 0.4 percent in 2003.

The Politics of Oil

Political climate is a huge factor in fluctuating oil prices. Countries in the Middle East, which produce much of the oil that industrialized countries consume, once used petroleum as weapon that incited an economic crisis there. Iran’s political revolution in 1979 caused an oil crisis. Since January 2002, U.S. crude oil cost has been up from less than $20 to $40 per barrel. Political factors like the September 11 events, other terrorist attacks, as well as the Afghan and Iraq wars are all attributable to the price hikes.

U.S. policy toward the Middle East is based on its demand for oil resources, to a large degree. But the military victory in Iraq has not ensured U.S. dominance of its oil market. On the contrary, terrorist attacks in that region, arguable exacerbated by U.S. aggression, have hindered the production and all major oil exporters. So, even minus OPEC’s decision to limit production, fluctuation in oil prices will occur under policies that spur political uncertainty.

Virtually complete reliance on foreign oil is fine for policymakers, if it’s cheap that is. But if oil gets too pricey, it could spawn domestic pressure to adjust energy strategies, since it is ultimately taxpayers who flip the bill, whether at the pump or in war appropriation bills.

Four decades ago, OPEC alone supplied 80 percent of the oil the world consumed. It accounts for only 35 percent today. Its ability to manipulate oil prices through adjusting the volume of production has therefore diminished.

Russia lists seventh in the world in terms of verified oil reserves. Last year, its crude oil output totaled 410 million tons, exporting 210 million tons. Both figures are second only to Saudi Arabia. Russia’s vast oil and gas resources are attracting oil companies from a slew of countries, including Britain, France, the United States, Japan, the Republic of Korea and India.

Africa is also abundant in oil. Sub-Saharan countries have verified oil reserves of approximately 75.4 billion barrels, 7 percent of the world’s total. Political instability and wars in the region and competition of major powers there are all linked to oil, directly or indirectly. As the region’s political situation stabilizes, it could become more strategically important to oil-thirsty countries. The detente between Libya and the West reflects the strategic willingness of major powers to allow economic interests to supercede moral qualms against trading. The United States allowed the signing of oil contracts with the former anti-America country, even as sanctions are not fully lifted.

From Where the Giants Drink

Rising oil prices also reflect the disparity of the international division of labor. Since the later half of last century, the global economy has been undergoing large-scale structural shifts, as the technological revolution and globalization marches on. Developed countries have upgraded their industrial structures, while service and hi-tech industries have come to constitute the biggest chunk of these economies. Energy-guzzling and heavy-pollution industries have, in turn, been transferred to developing countries. The industrialization and urbanization that is taking place in developing countries is gobbling up their resources and this new capital.

As shortage of energy grows into a global issue, developing countries are facing even gloomier prospects. Asia, the continent that consumes the most oil in the world, demanded 21.6 million barrels of crude oil per day in 2003, among which 64 percent was imported. China imported 91.12 million tons of crude oil last year, with its dependency on oil imports rising to 31 percent. As industrialization proceeds, the demand for oil of China and other emerging markets is expected to grow abundantly.

Since petroleum is not a renewable energy resource, developed countries are not in any hurry to exploit their own oil reserves. Import, for now, is preferable. Approximately two thirds of oil consumed in the United States is imported. Sixty percent of this is from the Middle East. The world’s top oil consumer and importer, it consumes around 20 million barrels of oil every day. As the Iraq dilemma becomes irreparable, and Venezuela, another major oil supplier, is at odds with the United States, Africa could become its next major oil provider. By 2015, the U.S. oil imports from Africa are expected to increase from current 15 percent to 25 percent in its total oil imports. At this point, 70 percent of the oil the EU consumes is imported. Major European energy companies buy mostly African oil, probably due to the historical colonial link. Competition among major powers will be fiercer, as regions of strategic world oil production shift.

Hand on the Price Gauge?

Competition for oil resources among major powers is prompting political weight to be tossed around in the global oil market. Countries are expanding their domestic oil reserves and meddling with international oil prices. Developing countries, which confront growing demands for oil amid their industrialization efforts, consequently, can do little about this.

The United States has had strategic oil reserves of more than 600 million barrels, which are expected to increase next year to 700 million. The U.S. policy to expand its oil reserves has pulled world oil prices up by $6 per barrel. Japan’s oil reserves can last a mere six months or so. In the meantime, a large number of idle funds from developed countries are also manipulating the oil price, while reaping enormous profits via futures transactions. These speculations have increased oil prices by approximately $8 a barrel.

Since developed countries are actually depending less and less on oil, by diversifying energy sources, soaring oil prices impinge relatively less on their economies. However, developing countries have limited, or even no, oil reserves and little leverage on international market. So, they are more affected by expensive oil. As long as an imbalance in ability to gain access to oil, and developing countries get weighed down by reliance on oil, developed countries will hold the reins of the global oil market, and the price of oil is their handy tool.