by Dr. J. B. Kelegama
The price of oil has remained above or close to $30 a barrel for more than two months, despite OPEC’s mid- September pledge to increase crude oil production by 800,000 barrels a day and the US decision on September 23 to release 30 million barrels a month from the US strategic petroleum reserve. In fact, futures markets are still anticipating the price to remain above $30 a barrel until April 2001. True, the announcement of the release of oil from the US strategic reserve mainly and Saudi Arabia’s assurance of oil supplies partly led to a fall in the world market price of oil from the peak of $36.26 a barrel in mid-September to $32.43 at the end of September and then to $29.62 in mid-October as shown below. In the third week of October, however, the price rose again, to $33.39 a barrel, declined to $30.89 in the last week of October and rose again to $33.43 a barrel at end of November.

The high oil prices are causing much concern in all non-oil exporting countries. The APEC meeting in Brunei in November agreed that volatile oil prices were not in the best interests of either consumers or producers and called for an increase in supply to meet current demand. World oil demand has risen by 0.9 million barrels per day this year and is forecast to jump by 1.9 million barrels per day in 2001, according to the International Energy Agency. The US and Europe sounded a warning to oil producers on November 18 that soaring crude oil prices were damaging the world economy, particularly in developing nations. US Energy Secretary Bill Richardson stated that $30 a barrel was too high and favoured a price of $20 to $25 a barrel. He added that OPEC still had the capacity to lower prices despite four output increases this year. The US is the largest oil importer in the world; it now consumes almost 20 million barrels a day, about 54 per cent of it being imported. Every $1 increase in the price of a barrel costs the US $20 million a day or $7.3 billion a year. The US is also worried because its crude oil inventories have dropped by 4.5 million barrels and are 8 per cent less than they normally are at this time of the year. This is mainly due to the oil companies’ move towards just-in-time management of stocks and deliveries. Companies are keeping far lower inventories than they might have done at this time of the year a decade ago. This increases profits by tying up less capital in stocks but the industry loses a valuable buffer.

OPEC’s Meeting in November

Despite the fact that oil prices had stayed above $30 a barrel for months, OPEC Ministers’ Meeting in Vienna on 13th November, put off until January 2001 any decision to change oil production levels. OPEC disagrees with the US Energy Secretary’s contention that the principal factor behind high prices was supply and low oil stocks. It is their contention that there is no shortage of oil supplies in the world. They estimate the world market for oil at 76 million barrels a day and it is oversupplied by 1.4 million barrels a day or by 2 per cent. They point out that after their four output increases amounting to 3.7 million barrels a day and the US release of 1 million barrels a day from its Strategic Petroleum Reserve, oil supplies by November had increased by nearly 5 million barrels a day. They predict that the crude oil price would soon fall into their target range of $22-$28 a barrel as the full impact of this year’s 3.7 million barrels daily of supply increases is felt. OPEC’s President Ali Rodriguez of Venezuela said: "We can only conclude that OPEC has more than fulfilled its role as a reliable oil supplier and that the true reasons for currently high prices lie behind a series of other factors". Among these factors, he referred to shrinking refinery capacity in the US, shipping and distribution bottlenecks and speculation on account of the fears generated by the Arab-Israeli fighting. Recent consolidation and tightness in the oil storage and tanker shipping businesses have both made the market jumpier. Rodriguez argued that the failure of the US to get prices down despite releasing one million barrels per day of emergency stocks from it Strategic Petroleum Reserve in November showed that extra supply was not warranted.

The OPEC further, estimates world stocks of crude oil and refined products such as gasoline are now equivalent to 80 days of demand which it considers as an equilibrium level. Stocks however, are still growing. It is not being reflected in the statistics because the data only shown primary stocks, but many factories and electricity generators have built up their secondary and tertiary stocks in advance, because they were worried about a price hike. According to OPEC’s projections, stocks could reach 90 days of demand and when this happens the oil prices are expected to fall. In fact, OPEC’s Secretary-General Rilwanu Lukman said: "The feeling we have now is that the market is getting perhaps a little saturated and as stocks build up it is likely to hit us in the face later in the new year if we don’t watch it. We do not want to overdo it and put the market in a state of jeopardy". Kuwait’s oil Minister too stated that supply and demand are now stable but expressed fears that the oil prices might collapse in the first quarter of next year if socks increase.

The OPEC emphasized that it was the market that should determine prices. Kuwait oil Minister Sheikh Saud Nasser al-Sabah said: "Industrialized countries had always asked us to allow market forces to work. Now we are demanding the same. I believe that having a fixed price for oil is difficult, if not impossible to achieve. The current situation is what the oil market demands, and any calls to fix the price are simply wishes". It is a fact that the developed countries, the IMF, World Bank and WTO have all preached the virtues of the free market to the developing countries and expected them not to interfere with market forces. In fact, whenever the developing countries complained about declining and unremunerative prices for their commodity exports, the developed countries and international institutions have argued that they could do nothing as the prices were determined by world market forces. The OPEC is now giving the developed countries a dose of their own medicine! It has further revealed that the developed countries’ laud market forces when the prices are favourable to them but not when they are not in their interest.

On the other hand, the OPEC appears to have shifted its ground from its original stand that it wanted the average price of cruder oil to stay $22-$28 a barrel and that it would raise production if the average price stayed above $28 per barrel for 20 trading days; further Saudi Arabia openly favoured the average oil price to be around $25 per barrel. Perhaps the OPEC has realized the futility of attempts to strive for price stability through unilateral market management — supply management — ignoring the demand for oil and bottlenecks in getting increased supplies to the consumer. In any case, there is little scope to increase supplies to bring down prices, for eight of the 10 OPEC countries except Saudi Arabia and Kuwait are already producing to capacity. Even if Saudi Arabia increases its production by an extra 1.95 million barrels a day (which is within its capacity) there would be little impact on prices because of the serious bottlenecks in refining, shipping and distribution and the building up of stocks.

The OECD calculates that a sustained oil price of $ 33 a barrel would cost 0.5 percentage points of growth in the European Union in 2001, 0.3 points in the US and 0.6 points in Japan versus the outcome if oil costs $28 a barrel.

Rising Demand for oil in Developing Countries

The importance of oil to the global economy has declined dramatically in the last thirty years. About a third less oil was used to produce an average unit of GDP in 1999 than in the early 1970s. (World oil demand divided by real GDP fell from I in 1970 to about 0.66 in 1999.) The sharp drop in oil dependency began after the price shock of 1973. Over the next decade, the global ratio of oil demand to GDP fell by 20 per cent. Oil demand diminished less dramatically in the late 1980s but it has dropped steadily since the Gulf War. Despite oil’s smaller role, there is still untapped demand for oil in the world. Asia’s emerging economies consumed only 1.4 barrels a person in 1999 and Latin American countries, 4.1 barrels, in contrast to US consumption of nearly 25 barrels per person, Japan’s 16, Euro’s 14 and UK’s 11. Emerging Asia’s share of global oil consumption has risen from 11 per cent to 17 per cent over the nineties and they are more oil reliant and twice as vulnerable to oil price increases than developed economies. As car ownership increases, these countries will become more oil reliant. The UN-ESCAP predicts that in 10 years Asia-Pacific will be the largest energy-consuming region in the world. It estimates that by 2005, the annual investment needs of the energy sector in East Asia alone will be in the range of $150 to $200 billion. High oil prices will tend to curb their economic growth, undermine the trade balance, stoke inflation and raise fuel subsidies. In fact, India’s growth is estimated to fall from the target of 8 per cent to 6.4 per cent this year. However, as the real price of oil is actually 20 per cent lower than during the Gulf War and half as much as during the mid-1970s, effects of high oil prices may be less severe than feared.

Asia

Analysts estimate that this year’s $30 average price for oil has increased consumer prices by 0.5 per cent in the Philippines, 0.4 per cent in South Korea and 0.6 per cent in Thailand and cut GDP by 0.2 per cent in the Philippines, 0.2 per cent in Singapore and 1.8 per cent in Korea. A Chase Manhattan study estimates the impact of every $10 a barrel rise in price at 0.3 to 2.2 percentage points in added inflation and reduced output, depending on the country. Even oil exporters in Asia will face trying times. Malaysia for instance, will benefit from higher oil prices, but petroleum makes up a mere 5 per cent of its exports so that gains would be more than offset by fall in exports of manufactured goods like appliances and electronics which may be hit by rising oil prices in industrial world markets. Indonesia too benefits from higher oil price, but it needs to spend more to keep local gasoline and kerosene at their hugely subsidized prices of 12 and 3 cts. a litre, respectively. The fuel subsidy in Indonesia is more than $5 billion or ten times social welfare spending. Further, about 30 per cent of the cheap refined products are smuggled into neighbouring countries. Under IMF’s pressure, Indonesia has agreed to reduce gas subsidies by 12 per cent. Malaysia too subsidizes gasoline, but to a smaller extent than Indonesia.

Generally, taxes on gasoline are relatively low in East and South East Asia as shown in the table. While Malaysia imposes no taxes, Indonesia imposes only a 10 per cent tax and the Philippines a 19 per cent tax. South Korea and Hong Kong taxes over 50 per cent but they are lower than 76 per cent tax in UK.

South Korea may suffer more than any other Asian economy because it is more oil reliant; it uses comparatively more energy than Japan or US to produce a given amount of GDP because the structure of its economy is different. It has fewer service companies and in general, lower value manufactured output than its more developed counterparts. Low oil prices have tended to Increase oil consumption in East Asia. While the higher oil prices resulted in developed countries moving away from complete dependence on oil, by such devices as developing alternative energy sources, making industry more efficient and converting gasoline to LPG run vehicles, little has been done in Asia to reduce excessive dependence on oil.

India hiked retail price of petrol by about 8-10 per cent, diesel by 18-19 per cent, kerosene oil by 48-50 per cent and liquefied petroleum gas (LPG) by 18 per cent on September 29 to curb an oil deficit following higher global prices. This caused some dissension in government ranks and some of the coalition partners demanded a rollback of the price increases. India’s annual oil consumption is about 100 million tonnes of crude oil and local production has been static for the past few years at 32 million tonnes. As its oil imports bill of $ 17.5 billion is putting pressure on its foreign exchange reserves, it is seeking to purchase oil on credit from OPEC.

Sri Lanka’s oil Imports

Sri Lanka’s crude oil imports rose from about 13 million barrels in 1990 to 16 million barrels in 1998 and then declined to 14 million barrels in 1999. The C & F price of crude oil imports averaged Rs. 879 a barrel or approximately $13.61 in 1998; this was when the crude oil prices were at the lowest level. Thereafter, the average import price rose to $ 19.06 in 1999 and then to $31.40 in September 2000 as shown in the table. The expenditure on petroleum Imports was only 5.9 per cent of the country’s total import bill in 1998 but with the world market price increase, the proportion rose to 7.2 per cent in 1999. This proportion is lower than that of the more oil dependent Japan and South Korea where it is 16 to 17 per cent. Sri Lanka’s dependence on oil, however, is rising with the new registration of over 100,000 motor vehicles a year.

Prices of Petroleum products have been raised by the authorities in recent months but these price increases appear to be inadequate to cover the higher costs of oil imports in full. The Treasury estimates that while a profit of Rs. 10-12 per litre is made on petrol, a loss of Rs. 7-8 per litre is made on diesel and a, further loss of Rs. 8-9 per litre is made on kerosene. The Petroleum Corporation states that it could operate at break even level only if the average crude oil price remained at around $20 per barrel. The price increases have already resulted in reduced profits or bigger losses to the Sri Lankan Airlines, railways and bus transport and there are demands from these sectors to revise their fares upwards. Increase in fuel prices inevitably has led to higher consumer prices and a rise in the cost of living. The higher oil prices have been aggravated by the depreciation of the rupee. Further, increases in the domestic prices of fuel may be unavoidable if the world market remains around or above $30 per barrel and this means that further increases in consumer prices and the cost of living also would be unavoidable. The higher oil prices would also tend to widen the country’s current account deficit and hasten the fall in its foreign exchange reserves. Sri Lanka exports some petroleum products from its refinery but they amounted to $74 million in 1999 or 17 per cent of its petroleum imports of $426 million.