Crude oil and its derivatives epitomize the notion that besides matching bids and offers, there often lies in the background a multitude of factors, which not only affect prices but also, and more importantly, the perception about supply, capacity, consumption and relative tightness/availability of the product. The movements in crude oil have been, to a large extent, a barometer of political and economic guesstimates – and the massive run up in prices will no doubt have an effect on the global economy. It is not so much the nominal level of prices that leads to alarm, but the trajectory and what prices are in effect “saying” about the future.
Since the Asian crisis of 1998, often a key data point in markets, prices of light sweet crude oil have quadrupled from just below $10 to nearly $42. The rise, from a technical standpoint, has been reinforced by several NYMEX closes above $40. While it is true that oil and other commodities have benefited from a surging Chinese economy, it is an aspect often de-emphasized, as the recent China numbers are utterly unsustainable and the true driver will be sentiment toward Middle East politics.
Oil prices still matter to the health of the world economy. Higher oil prices since 1999 – partly the result of OPEC supply-management policies – contributed to the global economic downturn in 2000-2001 and are dampening the current cyclical upturn (world GDP growth may have been at least half a percentage point higher in the last two or three years had prices remained at mid-2001 levels). Fears of OPEC supply cuts, political tensions in Venezuela and tight stocks have driven up international crude oil and product prices even further in recent weeks. By March 2004, crude prices were well over $10 per barrel higher than three years before.
Current market conditions are more unstable than normal, in part because of geopolitical uncertainties and because tight product markets – notably for gasoline in the United States – are reinforcing upward pressures on crude prices. Higher prices are contributing to stubbornly high levels of unemployment and exacerbating budget-deficit problems in many OECD and other oil-importing countries. In Lebanon, the situation and its impact at the gas pump has added yet another restraining factor to the Lebanese economy, and infuriated motorists.
The burden of higher energy prices places Lebanon in an even more vulnerable position in terms of the costs of “doing business,” and shakes the household spending patterns as more money is diverted to filling the tank. This has compounded the other issues facing the economy, be they punctual like the Euro rise, or structural like under-investment, lack of system credibility and massive fiscal imbalance. While it is true that policy can do little to counteract the rising cost of energy, such a shock, were it to continue, would amplify the layers of problems facing the country, and add to social angst. The addiction to gas guzzling SUVs may be coming home to roost, and taxi drivers can barely make ends meet.
Globally, the vulnerability of oil-importing countries to higher oil prices varies markedly depending on the degree to which they are net importers and the oil intensity of their economies. According to the results of a quantitative exercise carried out by the IEA in collaboration with the OECD economics department and with the assistance of the International Monetary Fund research department, a sustained $10 per barrel increase in oil prices would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. Inflation would rise by half a percentage point and unemployment would also increase.
The OECD imported more than half its oil needs in 2003 at a cost of over $260 billion – 20% more than in 2001. Euro-zone countries, which are highly dependent on oil imports, would suffer most in the short term, their GDP dropping by 0.5% and inflation rising by 0.5% in 2004. The US would suffer the least, with GDP falling by 0.3%, largely because indigenous production meets a bigger share of its oil needs. Japan’s GDP would fall 0.4%, with its relatively low oil intensity compensating to some extent for its almost total dependence on imported oil. In all OECD regions, these losses start to diminish in the following three years as global trade in non-oil goods and services recovers. This analysis assumes constant exchange rates.
The adverse economic impact of higher oil prices on oil-importing developing countries is generally even more severe than for OECD countries. This is because their economies are more dependent on imported oil and more energy-intensive, and energy is used less efficiently. On average, oil-importing developing countries use more than twice as much oil to produce a unit of economic output, as do OECD countries. Developing countries are also less able to weather the financial turmoil wrought by higher oil-import costs. India spent $15 billion, equivalent to 3% of its GDP, on oil imports in 2003. This is 16% higher than its 2001 oil-import bill. It is estimated that the loss of GDP averages 0.8% in Asia and 1.6% in very poor, highly indebted countries in the year following a $10 oil-price increase. The loss of GDP in the Sub-Saharan African countries would be more than 3%.
World GDP would be at least half of one percent lower – equivalent to $255 billion – in the year following a $10 oil price increase. This is because the economic stimulus provided by higher oil-export earnings in OPEC and other exporting countries would be more than outweighed by the depressive effect of higher prices on economic activity in the importing countries. The transfer of income from oil importers to oil exporters in the year following the price increase would alone amount to roughly $150 billion. A loss of business and consumer confidence, inappropriate policy responses and higher gas prices would amplify these economic effects in the medium term. For as long as oil prices remain high and unstable, the economic prosperity of oil-importing countries – especially the poorest developing countries – will remain at risk.
The impact of higher oil prices on economic growth in OPEC countries would depend on a variety of factors, particularly how the windfall revenues are spent. In the long term, however, OPEC oil revenues and GDP are likely to be lower, as higher prices would not compensate fully for lower production. In the IEA’s recent WORLD ENERGY INVESTMENT OUTLOOK, cumulative OPEC revenues are $400 billion lower over the period 2001 to 2003, in which policies to limit the growth in production in that region lead to on average 20% higher prices. The hike of future prices during the past several months implies that recent oil price rises could be sustained. If that is the case, the macroeconomic consequences for importing countries could be painful, especially in view of the severe budget-deficit problems being experienced in all OECD regions and stubbornly high levels of unemployment in many countries.
Fiscal imbalances would worsen, pressure to raise interest rates would grow and the current revival in business and consumer confidence would be cut short, threatening the durability of the current cyclical economic upturn. Europe has felt the oil surge to a slightly lesser extent recently as the Euro has surged by nearly 40% against the US dollar, but further gains could be crippling, especially given the high tax structure prevailing in the continent.
Oil has also had a role in reflecting the weaknesses in US foreign policy. As such it represents yet another thorn in the side of the neoconservative establishment plans to effectively “rule the world.” One of the platforms of US policy in Afghanistan and the obvious hidden agenda in Iraq has been to secure the oil to satisfy the gas guzzling addictions of the US consumer. So far, the result has been an unadulterated disaster. Not only has oil continued to climb, but the recurring incidents in the Gulf have added a risk premium that had not existed before the Iraq adventure began. In sum, Bush and his oilmen in power are responsible for what promises to be the most expensive driving season in decades.
For developing markets such as Lebanon, where oil intensity is still high, the impact of higher energy has the effect of a large tax, which is acting as a drag on economic activity through a compression of disposable income. The net effect though, can be more mixed over the medium term, if the higher energy can be offset by higher growth in the Gulf and more remittances from Lebanese expatriates as well as more Gulf tourists. But that’s a long shot. The true impact is, in the short term, to choke further any sign of upturn in the Lebanese economy.
The following is a detached look at where prices can go based on the below chart. Unless crude oil can break back significantly below $36 a barrel, we are staring at stubbornly high prices, maybe toward $50. But since this is the most political commodity, and the effectiveness of OPEC at guiding prices is almost as ineffective as central bank currency intervention, prices will tend to overshoot before falling along with other commodities. The risk of prices staying high at this juncture stems from external factors – such as the total loss of control of the situation in Iraq, or worse, further unrest in the Arabian Peninsula – rather than from the notion of a booming world economy. The world economy, at best, has experienced a temporary lift, and will soon revert back to sluggish growth and sticky unemployment, providing a weak backdrop for most industrial commodities.
SUVS TAKE A BACK SEATBuyers turn to more fuel efficient, smaller engine automobiles as petrol prices continue to bite – By Anthony Mills
Hussam Batrouni, 24, manager of the Petit Café, only uses his eight-cylinder Ford Expedition at night – he is looking for a four-cylinder daytime car. Elsewhere, Kamil Roumieh, a 25-year-old inventory controller, has been forced to buy a modest a four-cylinder 1.4l Renault Clio. He used to have a bigger six-cylinder car but couldn’t afford to commute. He is one of the lucky ones. Many cars owners now find they are unable to offload their gas-guzzlers and are faced with crippling petrol bills of up to $500 a month. Other commuters are simply discovering the delights of taking the bus to work.
The government’s recent pledge to cap gasoline prices at LL25,000 (nearly $17) a 20-litre tank, must be of little consolation to Hussam and Kamil, who have seen petrol rates almost double in six years, as global crude oil prices climb to record highs in a country already plagued by stagnant salaries and general economic malaise. As consumer attention, in the roughly 15,000-car, $220 million market, shifts towards new, smaller, more efficient four-cylinder cars, overall demand for new cars has risen by almost 50% in a year (used car salesmen, for their part, speak of a 40% drop in sales). Today Size does matter.
“A year and a half ago, customers started becoming more gasoline-cautious. The name of the game used to be power. Now it is fuel efficiency,” declared Samir Homsi, president of the Association of Automobile Importers. The old theory was that bigger cars were better because they were safer. Tell that to T. Gargour & Fils – better known as agents for Mercedes – who are receiving increased interest in the diminutive, two-seater Smart car which, despite scoring impressive crash test results, looks like it would blow away on a windy day. The attraction is the car’s staying power: 500km per 20 liters of gas. “More and more people are asking about it,” shrugged Cesar Aoun, Gargour brand manager.
At the other end of the scale however sales of 12-cylinder super cars have not been affected as much as their six- and eight-cylinder cousins. “We haven’t seen much of an impact on high-end cars,” confirmed Kamel Abdallah, deputy general manager of Kettaneh, which imports Porsche, Volkswagen and Audi. “It is the middle segment that has shrunk most drastically.” One sales manager for a major distributor defined this shrinkage as a 60% to 70% slump in sales, a phenomenon that has not been helped by a strengthening euro, which alone has been blamed for a 20% to 25% hole in the market.
Sales may be up in the budget range, but importers are having to sell more of the smaller models to make up for the decline in sales elsewhere. “We have to work twice as hard,” acknowledged Abdallah, who will throw-in an airline ticket to Cyprus for every sale of the new Volkswagen Gol. Some dealers, under pressure to keep sales up, are resorting to disingenuous tactics. “Because the business has become so tough, some companies are bordering on unethical practices in their promotion, just to get around the tougher market and increase in prices,” said Abdullah. Certain dealerships – which he declined to name – were being dishonest, or deliberately misleading, about cars’ gasoline consumption rates. And, he went on, advertisements stressing low installment rates sometimes deliberately don’t paint the whole financial picture.
Elsewhere, in their effort to boost sales, importers are luring in customers with low-interest installment schemes and longer guarantees. “We are trying to facilitate everything for the client, so that they forget about fuel consumption,” one salesperson said.
At least 50% of Kettaneh’s car sales are through bank-financed credit. In tandem with rising petrol prices and a worsening economy the company has established joint programs with banks to promote sales. At the same time, this represents a conscious move away from in-house financing which was fast becoming an unsustainable risk. “The overall economic situation does not justify extending credit terms as we used to,” said Abdallah. “We are transferring our risk.” He was echoed by Ziad Rasamny of Rasamny-Younis: “Our target is to do less in-house financing and to rely more on banks.”
The association has also been imploring the government to reduce high customs taxes on cars, and heady registration fees, which are pushing up end prices and ultimately stunting importers’ efforts to sell. Importers stress that the newer, more fuel-efficient a car, the better it is for Beirut’s smog-filled environment.
Used car dealers, too, are shifting towards the smaller-engine market. “Before, the Lebanese liked to buy top-notch used cars with six, eight, even 12 cylinders. Today, an eight-cylinder used car is very difficult to sell, a six-cylinder one you can just about sell,” explained the owner of a car lot on the old Sidon road. “The best is four cylinders.”