Shock effects

Arun Chaubey

The increase in oil price has contributed to fears of an economic recession on the one hand, and on the other it has led to growing number of protests and demonstrations in developing and developed countries around the world. The price hike is being attributed to a confluence of factors, including reports from the US Department of Energy and others showing a decline in petroleum reserves, worries over peak oil, Middle East tension, and oil price speculation.
While crude prices increased 400% from 2003–2008, United States gasoline prices did not rise by the same factor. There is one point of view that oil-price hike would create a recession comparable to those that followed the 1973 and 1979 energy crises, while others visualise a potentially worse situation such as a global oil crash.

Inflation

The increase in oil price differs internationally according to currency market fluctuations and purchasing power of currencies. As oil prices keep rising, transport costs could cancel out lower wage advantages in places like East Asia.

Despite the rapid increase in the price of oil, neither the stock markets nor the growth of the global economy were affected significantly until supply declined rapidly in November 2007. In the United States, inflation increased; averaging 3.3% in 2005–2006, as compared to an average of 2.5% in the preceding 10-year period. As a result, during this period the Federal Reserve has consistently increased interest rates to curb inflation.

The surging food prices in the Philippines pushed the inflation rate in May to 9.6 percent, the highest level since 1999. The Philippines, one of the world`s largest rice importers, has been hit hard by a worldwide rise in the price of rice. While in Indonesia, oil troubles are coming home to roost, posing a growing challenge to President Susilo Bambang Yudhoyono`s ability to maintain economic stability.

In Spain truckers went on strike to protest rapidly rising fuel prices. They blocked principal routes into major cities around Spain and refused to transport food, fuel and a range of other supplies, including new cars.

In India also, the UPA government is struggling hard to control inflation as it has touched double digits. The ruling Congress party has dubbed it a global phenomenon. But it is struggling to rationalise it before its electorate, as the general elections are round the corner.


Impact on US, Europe & Asia Pacific

The United States no longer makes as many goods, it does not expend as much energy as it used to do. Higher energy prices have also impacted the cost of the goods that are manufactured overseas. The increased cost impacts the US GDP via the trade deficit. The increase in oil prices over two years was mirrored in an increase in stock prices in the energy sector. The stock prices of companies such as Apache and Conoco-Phillips rose sharply during this period. These prices increased more rapidly toward the end of August, particularly after Hurricane Katrina. Besides, Wal-Mart shares have continued their downward spiral in tandem with rising oil prices.

In the developed countries of Western and Central Europe, the prices of transport fuels are made up of the price of the refined product, plus a substantial tax element. In the UK nearly 70% of the price of a litre of petrol is made up of fuel duty and VAT. A doubling of the oil price would add about 30% to the cost of fuel at the pump in the UK, if the duty was not changed.

The Pacific rim had been experiencing chronic oil shortages prior to Hurricane Katrina. Some countries are increasing production of biofuels to offset the higher costs of oil.


Developing nations

High oil prices are likely to first affect less affluent countries, particularly the developing world. The World Bank has looked more deeply at the effect of oil prices in the developing countries. An analysis finds that in South Africa a 125 percent increase in the price of crude oil and refined petroleum reduces employment and GDP by approximately 2 percent, and reduces household consumption by approximately 7 percent, affecting mainly the poor. While it also hurts many countries in Africa, including Zimbabwe, Eritrea and Tanzania, it has also created an oil supply instability, per barrel price instability or both. Many countries in Sub-Saharan Africa lack the foreign exchange reserves to purchase enough oil products at increasingly higher prices.

Venezuela`s President Hugo Chávez came under increasing scrutiny as he began selling oil at lower-than-market prices to poor US consumers, and to island nations in the Caribbean such as Cuba.

Transportation

Motorists used to opt for larger, less fuel-efficient sport utility vehicles and full-size vehicles in the US, Canada and other countries where fuel taxes have historically been low, but this trend witnessed a setback in 2008 due to rising prices of fuel along with an increasing perception that future fuel prices will be at least as high.

If we look at air travel, during the 1980s oil glut, Jet fuel costs were low and air travel enjoyed robust growth around the world. However, the run-up in oil prices after 2003 began eroding airline profits, and the doubling of oil prices from May 2007 to May 2008 had a substantial impact on airline operations.

The world has seen changes in transportation, like the recent move towards containerization, which effectively makes shipping costs more vulnerable to swings in fuel costs. Container ships can be unloaded much faster than break cargos so they spend much more time at sea than in ports. Another factor is speed. In global shipping, the increase in ship speed over the last fifteen years has doubled fuel consumption per unit of freight.


Food security

Since the 1940s, agriculture has increased its productivity largely due to the use of petrochemical derived pesticides, fertilizers, and increased mechanization. During this time, the world population has more than doubled. By late 2007, increased farming for use in biofuels, world oil prices at nearly $100 a barrel and growing consumer demand in China and India pushed up the price of grain. As of December 2007, 37 countries faced food crises, and 20 had imposed some sort of food-price controls.

The United Nations also hosted a three-day food summit in Rome where more than 40 world leaders discussed the global crisis. The summit cited high oil prices as one of the reasons for price rises besides several other reasons.