Monday, July 19, 2010

Oil tax on the global economy


By Shan Saeed-Economist/Banker

With fluctuation in oil prices, uncertain global oil market,? depressed supply situations, the global economy is set to welcome the advent of long recession of the modem era.

Signs are all there for a perfect blizzard coming at a very fast pace, Soaring oil prices touching $50 per barrel in the month of August and September all too palpable, supplies are tight.

The geo-political strategy has changed over a period of time. It is now the key natural resources of the world that buttress in manoeuvring any decisions of the world powerful leaders.

Sky-high oil prices has placed a reverse engine gear on the synchronized growth of the global economy which is under threat, not from inflation but from the deflation factor affecting the rising oil prices.

Supply situation is in doldrums: violence in Middle East and the situation Iraq, uncertain fate of the Russian Oil Conglomerate Yukos, the civil war in the oil-rich north-east region of Aracua in Colombia, insufficient capacity to meet the growing demands of the global economy, and the political instability in Nigeria are the factors playing havoc with the global market.

Oil is now 137% more expensive than it was in 2000 percentage-wise, resulting in 'oil tax premium' of $19 per barrel that consumers have to bear painfully. Higher fuel prices have caused unwelcome rise in inflation, restricting synchronized economic growth of the world economy. As prices rise, consumers turn cautious and profits fall, the countries' exports decline and trade deficits rise.

The received wisdom is that higher oil prices are negative for economic growth, particularly for countries which are heavy oil importers. Increasing oil consumption has reduced the profit margins of businesses.

Rising oil prices lead to higher business costs, cutting into profitability. The oil tax is increasingly becoming a tax on job growth, Many businesses, such as airlines will seek to pass this onto the consumer, cutting into household income.

PIA, Qantas, Air Canada, Singapore and its regional SilkAir have already increased the fuel surcharge on its flights in the month of August/September. Consumers are cutting down on their saving to pay for an extra dollar-of petrol per barrel.

Not all companies will be able to pass the costs into the consumer. But lower profitability could encourage them to lower their costs in other ways - perhaps even by getting rid of staff. Job and inflation effect of oil are closely related. High oil prices still act like a tax that hits consumers and businesses on a material and psychological level.

Sustained and synchronized recovery with higher growth is the answer key to the rise in oil prices. Oil consumption is growing at 10 per cent per annum. Countries that are thirsty for oil include China, India, Korea, Thailand, and Japan. China's crude-oil consumption is equivalent to nearly 70 per cent of the combined crude oil consumption of France, Germany, Italy and the United? Kingdom.

China's year-to-year demand has increased 14 per cent in June-July-04. With income rising, fuel hungry China is set to become the world's biggest consumer of Oil by 2007, It requires oil for its energy demand that is growing at 11.57 per cent. Energy is just one more cost for businesses to deal with at a time when shareholders are relentlessly demanding better profits.

At the same time, production capacity has not kept pace with the growing demand of the global economy. Blame goes to both the producing ccuntries and the national oil companies which have under-invested in bringing the new supplies to market.

OPEC contributed a lot which constitutes 73 per cent of the world oil reserves under its cartel group, in not investing heavily in updating the new refineries and adding value to the production capacity.

The oil cartel group imposed production cuts on its members to boost prices, thus discouraging governments in investing in production capacity of their refineries. Intervention by the US and its allies over Kuwait in 19911 was in large part motivated by a need to secure oil and also to prevent Saddam Hussein from expanding his access to it.

And, although the more recent war with Iraq had other motives as well, oil was a factor. Iraq is very rich in oil and most western countries [France, Germany] are already there to exploit the? situation The US Vice President Dick Cheney, once said, "Saddam ? Hussein could then be expected to seek domination of the entire? Middle East and take control of a great proportion of the worlds? energy supplies.

With no, quick solution in sight for Yukos, the Russian Oil giant that exports 1.41 million barrels per day, the American and British to capture the Caspian oil market have devised a new strategy.

Russian market valuation is dirt cheap ever though its cash- flow is booming oil and metal are on a roll, the central bank has over $ 90 billion in reserves. Russian rubble is one of the.

Most attractive undervalued petrocurrencies in the world. Yet as long as the Yukos crisis is not resolved, the Russian? story is a pariah on Wall Street. Looking ahead, new areas of interest are opening up, especially the Caspian Sea where a new "'great game'" is developing to mirror the rivalry between Russia and Great Britain in Asia in the 19th Century.

One of the countries at the heart- of Caspian Sea development is Azerbaijan and it is instructive perhaps to recall that its capital, Baku,? was once the capital of the world's oil exports.

Higher oil prices have adversely affected the global economy resulting in the downward revision on the economic growth predicted to grow by 3.73 per cent in 2004. Consumer spending is down by 38 percent tax on household spending falls disproportionately on the lower income group.

Auto industry, stock market and production firms have faced this brunt in the wake of uncertain oil supplies. With little surplus capacity available in the global market, supply disruptions in the oil producing countries in the Middle East, Russia, Nigeria and Venezuela can push prices above $55 per barrel.

Opec had almost 6 million barrels per day in extra capacity it could call on. The situation is that it's pumping close to flat-out. And $50, though a record in nominal terms, wouldn't match the $80, in core inflation-adjusted dollars.

If oil prices stay high, which I doubt, it will slowdown the economic growth, adding deflation instead of inflation, higher- interest rates, decrease in investment resulting in unemployment in general. However, price of oil will come down to a band of $40-44 per barrel by November but it is premature to comment on that at this point of time.

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