This week, the price of oil topped $30 a barrel for the first time in nearly a decade. Crude prices have been climbing for a year, and there is concern that they may rise still further. That has triggered worries about inflation, which could hurt the global economy. While concern is justified, fear is not. The world is not facing an oil shortage, but policymakers need to keep an eye on oil prices to ensure that they do not dampen the prospects for growth.
A year ago, oil cost about $11 a barrel. Prices have nearly tripled since then. Comments earlier this week by U.S. President Bill Clinton seem to have capped the most recent surge, but they could begin to climb again.
Prices are rising for two simple reasons: supply and demand. Economies are growing again. The International Monetary Fund projects 3 percent growth for 1999 and 3.5 percent this year. The Asian Development Bank estimates that developing economies in Asia should post 5.7 percent growth this year. That means the demand for oil, which averaged 75.5 million barrels per day in 1999, will grow to 77.3 million bpd a day this year.
Yet as global growth increases the thirst for oil, supplies are falling. Last year, production was 74 million bpd, a drop of 1.5 million bpd from the previous year. The chief culprit is the Organization of Petroleum Exporting Countries, which, after years of failure, has been able to keep its members in line and observing production quotas. OPEC’s average output in 1999 fell to 26.6 million bpd from 28 million in 1998. In addition, oil refiners have cut back production, further tightening supplies.
A final factor is Iraq’s decision to cut its oil exports by 10 percent. That move was fueled by Baghdad’s desire to make the United Nations more squeamish about its sanctions regime, which was imposed in the aftermath of the Persian Gulf War. While some oil is exported illegally, the mere threat of further cuts is enough to send jitters through the market, which increases prices.
As prices rise, so do inflationary pressures. A $10 increase in the price of oil boosts inflation about half a percentage point a year in the United States, and about 7.5 percent annually in Europe. The impact could be even greater in Japan, since the rise in oil prices would be amplified by yen devaluation against the dollar. Inflation fears could prompt central bankers to increase interest rates, which would slow economic growth.
That is the worst-case scenario, and it is unlikely to happen. While oil stocks are falling, countries maintain reserves that could be used to cushion supplies. While OPEC has succeeded in keeping members in line over the last 12 years, discipline is under strain. Nigeria, the world’s sixth-largest oil producer and a member of OPEC, has announced that it will more than double its production capacity in the next decade, going from 2 million bpd to 5 million by 2010.
Next month, the organization will be put to the test as OPEC oil ministers meet to review production and work out future output levels. Saudi Arabia, the world’s largest oil producer, has vowed to keep supplies stable and see that prices avoid volatile swings.
At the same time, inflation fears have lessened because developed economies have become more efficient. Oil prices do not have the same impact they once did. Two decades ago, for example, oil accounted for 8.7 percent of every dollar of the U.S.’ gross domestic product. Today, it is about one-third of that. A tripling in prices in one year is severe, but they started from an extremely low level. And since prices worldwide are under deflationary pressures, there is slack to absorb the increase.
On the other side of the equation, low prices squeeze economies that rely on oil production. If prices are so low that revenues do not cover the cost of production, those governments will cut output. If prices are at the break-even point, they ignore their quotas, increase production and flood the market with crude, which only exacerbates the problem. Refiners also cut back their activities when profitability drops, as they have been doing over the last few months.
The bottom line is that the world needs stable oil prices. A return to global growth should nudge prices up over the long term, but that need not be alarming. All the swings cannot be eliminated, but judicious policies on the part of consumers and producers can take some of the volatility out of the market.
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