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Oil Prices: Fear Factor For 2005

Supply and demand shifts could drastically affect local and global economies


December 23, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

Of all the new-year predictions running wild in the economic sector, one rings true even to the skeptics: oil prices could create a slippery slope for the economy in 2005.

With China and India wrestling for Iran’s oil, and both countries increasing demand at exponential speed, supply and demand could be shifting drastically in the near future. Oil-price instability has everyone scrambling, including OPEC which, on Dec. 10, decided to cut its production supply by as much as 1 million barrels a day, following a sudden drop in prices. After a high of $55.17 a barrel in late October, the current price of oil for January delivery registered last week close to $44 a barrel on the New York Mercantile Exchange. The present cutback in price promises to be short-lived, as cold winter fears menace consumer’s pockets in the mainland U.S.

Although the winter season doesn’t affect Puerto Rico, the island still feels the economic impact of higher oil prices. According to the P.R. Planning Board, in 2004, Puerto Rico imported 80,884,000 barrels at an average price of $32.70 per barrel, compared with $30.20 in 2003. Gasoline prices feel a direct hit by the increment in oil prices, especially considering the high volume of automobiles on the island. However, gasoline and energy prices aren’t the only way the Puerto Rican economy is impacted by oil prices. According to a new study prepared by Heidi Calero Consulting Group Inc., for every 20% increase in oil prices, inflation goes up one point, and Puerto Rico spends $400 extra million on oil. At the moment, oil prices have increased 30% from last year.

All sectors of the economy feel this impact. Apart from the obvious victims of oil prices, such as transportation services and energy providers, others such as domestic services, security brokers, legal services, commercial banks, hospitals, and physicians also feel the impact to some degree.

On the global front, there are two schools of thought on how much of a factor oil prices will figure in the world economy in the coming year. There are the pessimistic and the less pessimistic. Even the optimists, who anticipate oil prices will level out in the latter part of the year, warn of potential price spikes due to vulnerable conditions in oil-producing countries such as the Middle East, Venezuela, and Nigeria. The pessimists see increasing demand from developing markets as a powerful menace to the current supply level and, consequently, as a major trigger for increased oil prices. They are mindful that this year’s increase in demand was the biggest in over 16 years, although oil prices haven’t reached the height they have in the past. According to estimates by Quality for Business Success Inc. (QBS), in 1980, the price for a barrel of oil was $81 in today’s money. An even more extreme example, in 1864, prices reached $8 per barrel, the equivalent of $92 in 2004 dollars.

Oil demand by China has increased at shocking speed. In 2003, car purchases alone increased by 70%. Today, China accounts for 12.1% of the world’s energy consumption. This year, it became the second-biggest oil user in the world, behind the U.S. By 2020, China could be consuming up to 11 million barrels a day. Although experts say the demand increase by the most populous nation in the world was to be expected and may even slow by next year, India’s demand for crude oil has taken many by surprise.

According to India’s Planning Commission, the country needs to triple its energy generation over the next two decades to feed its fast-growing technology and manufacturing industries. The massive overall economic development of the country will greatly affect the current oil supply & demand pattern in the world, as well as energy investment flows. Both China and India currently are competing for contracts with oil-producing nations to ensure their energy demands will be met. These contracts are all in the Middle East region, and there is little chance U.S. companies will share in the profits.

The combination of these factors has led some economic forecasts to cut economic growth predictions for the U.S. as well as for all other industrialized economies. Among those putting forth gloomy forecasts is the Organization for Economic Cooperation & Development (OECD), as well as the National Association for Business Economics. Back in October, Federal Reserve Chairman Alan Greenspan agreed higher oil prices have had a noticeable effect on the U.S. economy this year, and more instability is to be expected. According to the Economist, OPEC has managed to transfer a staggering $7 trillion in wealth from U.S. consumers to producers over the past three decades by keeping the oil price above its true market-clearing level.

The U.S. isn’t alone. According to estimates prepared at Morgan Stanley, growth in Europe, Japan, and the U.S. combined is projected to slow early next year to a 1.5% annual rate. Some economists believe this speed could easily give way to a recession. Many companies are preparing their budgets based on $45 a barrel prices, which will affect consumers’ pockets in many ways.

Then, there are the concerns over the depleting oil supply in the world. Last year, world consumption was over 80 million barrels a day. In 2003, North America, the world’s No. 1 consumer of oil, used 24,083,000 barrels each day. Experts believe world demand for oil will grow by another 60 million barrels a day by the year 2015. As demand grows, experts fear the peak of the world’s oil supply is nearer by the day. Although estimates vary widely, they coincide in the fact that most middle-aged citizens will witness that peak in their lifetimes. The numbers are on their side. The fact consumption is around 29 billion barrels of oil a year, but only 6.8 billion barrels of oil in the same period are being discovered from new sources, doesn’t offer much hope. Rather, hope is being placed on the development of new drilling and refining technologies, as well as energy-saving machinery and conservation methods.

Puerto Rico serves as a good example of this fact. Around 33% of the island’s electricity comes from two nonpetroleum-dependent power plants that function as co-generators to Puerto Rico’s Electric Power Authority (Prepa). One of them is EcoElectrica, which depends on natural gas, and the other is Applied Energy Systems (AES), which uses coal. According to Joaquin Villamil, from Estudios Tecnicos, these plants have helped to some degree to soften the effect in Puerto Rico of higher oil prices.

What history seems to have proved with respect to oil prices, is that as most economic functions, these prices are all part of a cycle process. What many hope is that high prices will encourage oil companies to go out and look for new oil, and all the money they are making will be reinvested in additional oil exploration and production. At this point, the effect of increased prices has only been mild.

QBS calculations say the oil shocks will likely only subtract 0.9% from U.S. real GDP. On the more troubling side, the fact OPEC would cut supply with oil prices in the $40 per barrel range, may be an indication oil prices appear to have moved more or less permanently to a higher range than the old $20 per barrel long-term average. The fact is the triggers behind the recent surge in prices are likely to persist, so businesses and the world economy as a whole will have to learn to adjust to avoid oil-price volatility to condemn it to dangerously poor growth in the future.

This Caribbean Business article appears courtesy of Casiano Communications.
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