Oil Price Spike - A Flash In The Pan?

15 April 2002

The 'double entendre' (double meaning) in the caption of this article, is intended to highlight the acute economic impact of the petroleum price rise implications; particularly in the backdrop of the escalating Arab-Israeli crisis. The ten (odd) Dollar increase in oil prices since the beginning of the year, can prove to be just as explosive to the fragile global economic recovery and turn out to be just as much of a trigger or a flashpoint; as the deeply tragic denouement and deterioration in the West Bank and the Palestinian diaspora. The Saudi Oil Minister has said that oil will not be used as a weapon in the current crisis. As Saudi Arabia has the largest reserves and can easily galvanise into a 'swing producer' of great substance, his words will no doubt serve to stabilise the market sentiment. On the other hand, fiscal prudence in Saudi Arabia and Kuwait may suffer if petro-dollars cover fiscal deficits and mask their structural economic problems that call for appropriate austerity and liberalisation. Reforms will be undermined if budgetary pressures ease, because of the oil price bonanza. Ministerial pronouncements may smoothen the frayed nerves all around but has done little to dampen the speculative surge in the spot market oil prices.

Last week, I had an interesting conversation with a diplomat in Vienna; which has in the last two decades, emerged as the epicentre for OAPEC and OPEC confabulations. Some oil experts do question as to why, when bulk of the production emanates from the Middle East, should energy congregations happen in Vienna! Quite apart from the International Atomic Energy being headquartered there, Vienna's perceived neutrality is similar to that of Switzerland and has functioned as a 'non-aligned' venue; in a manner of speaking. Some years back, the Mariott hotel (also housing the U.S. Embassy officials) had been the meeting venue but when bugs were found on the wall (quite literally!), many hurried to shift to Geneva, until the Austrian authorities reassured the gathering and swiftly created a purpose-built permanent venue for the frequent international 'oil' ministerial meetings.

True that heavyweights such as Indonesia, Nigeria, Venezuela, Russia, Mexico and Brunei, major oil producers including the U.S., Norway and the U.K. - all lie outside the OAPEC group (or cartel as it is sometimes derided in the West). Nevertheless, a matter of some concern to the analysts has been the Russian (oil)behaviour since last year, when it chose to pump its way out of its financial problems; quite in violation of the OPEC quota and production allocations. This has been causing a little friction to the GCC producers and in particular, to the Saudi authorities. Reportedly, Russia has a huge problem. It cannot shut down its production capabilities because its maintenance quality and capabilities are poor and its reinvestment in technology have been low. If it stopped pumping, it will just fall down flat - like a marathon runner!

Be that as it may, the recent threat by Iraq to shut off supplies for a month, it is believed, could remove some 10% of the OPEC but only about some 2% of the total global production. Therefore, in itself, this is not going to make a huge material impact; other than on the 'sentimental injury' in the spot markets. However the Iraqi declaration, coupled with the news of the Venezuelan oil workers' strike and the political ramifications thereof, did not help. Perversely, the coup d'etat in Caracas over the weekend and the resumption of production by the Venezuelan workers, resulted in a fall in spot oil prices!

Unfortunately, when oil prices rise in a secular fashion, it can stall the world's economic recovery efforts. If sustained, this can result in yet another recession, similar to the '70s. While this may not come to pass, of course, the situation is not quite the same as what it was, then, in terms of both consumption levels as well as diversification of energy sources and resources. But when the economic growth trajectory is fragile, the much needed improvement in the emerging markets will receive a severe setback; if the oil prices stay as high they do. It will certainly help plug the GCC fiscal gaps, resulting in a buoyancy in this part of the world. But that would be at the direct expense of the developing countries and oil starved nations such as Germany. High prices may well bring into play, wells that had been previously capped, in the U.S (West Coast and New Mexico) because the price situation was not viable enough earlier for restarting them.

Some of the lethargy and complacency that had set in, over the last three decades in terms of energy conservation, alternate fuels and research will now have to be cast aside and there will yet again be a spirited attempt to preclude all and any adverse impact.

It is a pity that the emerging markets will bear the brunt of a large transfer of wealth caused by the oil price hike. This is where countries in the GCC, Indonesia and the like, will need to examine as to how much they would want to destablise their friends and how best to help alleviate social suffering in the poorer parts of the Arab world, Africa, Asia, Latin America and elsewhere, whose economies have to take the biggest knocks. Indeed, Iraq might end up cutting off its nose to spite its face, so to speak, even if its stated intention is to exacerbate the pressures on the U.S., which it sees as a villain of the piece in the new Arab conflict. But it is not the U.S. that consumes Iraqi supplies or much of the OPEC oil. Therefore the Third World countries' welfare will now be put at risk by the steep increase in oil prices. As they say, the road to hell is often paved with good (or misplaced) intentions!

Ultimately this is an interdependent world and any economic slump will eventually cut in fuel consumption, which in the medium term, could be to the detriment of the oil producing countries themselves. In the first year or so (and during the period of maladjustment), their coffers will fill fast but not for long! There ought to be other political weapons / measures such as repatriation of capital, focus on cultivating and growing trade with friendly countries; as opposed to those that have been the perpetrators of mischief and / or who turned a blind eye to the Arab suffering. All these need to be part of an economic, trade and investment package or blue-print that should reward friends and penalise the others; but in a well orchestrated manner. Similarly there is a large Arab population that can be galvanised to produce a human wall / shield against political and military excesses. These approaches should be far more effective than summit meeting confabulations or gestures, some of which may do more harm than help; especially when undertaken in a fit of righteousness. Justice, equity and considerable world sympathy is very much on the Arab side, and it is possible to channelize them into a potent force to foil evil plans by the designated enemy. This is where there is a crying need to develop strategies, in a cool and collected manner.

The oil price hike arguably is too obvious and too indiscriminate a weapon in the Arab armoury but one that could provoke a market backlash; with wholly unintended economic hardship and consequences. As the seasoned experts would say, in global trade and financial market places, the rules of engagement and confrontation need to be couched in 'a velvet glove'; so that the punch is regarded as a 'pat' and yet it knocks out the opponent! That is the equivalent of a Machiavellian (economic) piece of advice!

(The author (sureshk@emiratesbank.ae) is a General Manager in Emirates Bank Group. The views expressed in this article are not necessarily shared by the Bank.

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