Even though recent unrest in the Middle East has been limited to countries that have little effect on the global supply of oil, uncertainty in the oil markets has surged and prices have increased significantly. If prices rise further and stay elevated for a period of time, the global recovery could be in danger.
Carnegie’s Christopher Boucek, Mohsin Khan of the Peterson Institute, the World Bank’s Hans Timmer, and PFC Energy’s Jamie Webster discussed the complex set of political and economic issues shaping today’s oil markets. Carnegie’s Uri Dadush moderated.
Today’s Oil Price
Even before turmoil broke out in the Middle East, the global recovery—and rising demand from emerging markets in particular—had placed upward pressure on oil prices. The Brent Crude oil marker, which is used to price the majority of crude oil, was at $90 per barrel in December. Since then, little has changed in the oil market’s supply and demand, but, Webster explained, market fears have caused Brent to surge to $115 per barrel.
- Market Fundamentals: Webster explained that the biggest changes in the Middle East have so far occurred in countries that have only modest effect on the actual oil market. Tunisia is neither a large supplier nor consumer of oil; Egypt’s Suez Canal and Sumed Pipeline have not posed a transit risk; and the disruption in Libya’s production poses only a modest production risk. Furthermore, Saudi Arabia and the Emirates, which have not seen widespread protests, have unused oil capacity that can offset the decline in Libyan exports. Based on market fundamentals, Webster said, the oil price should be closer to $80 or $90 per barrel—near the lowest price Saudi Arabia requires to cover all its government spending.
- Market Fears: Oil prices are significantly higher, however, because investors are worried that unrest could erupt in Saudi Arabia, the region’s biggest oil producer and supplier of reserves. According to Boucek, however, revolution is not likely there. Saudi Arabia is deploying a powerful mix of force, religious ideology, and public spending to quell unrest.
Though the oil price has risen, Timmer noted that price volatility was low in March. Even as events unfolded in the Middle East, the price held steady, suggesting that forward-looking oil markets had already taken the unrest into account. Feedback mechanisms that keep the price from surging too high and a healthy oil supply may also have helped.
If another disruption affects supply, prices could spike very quickly, with potentially dangerous implications, the panelists warned. Khan cited research by the International Monetary Fund, which determined that a sustained price of $120 per barrel—not far from the Brent marker’s recent $115 per barrel—would inflict some damage on the world economy. Under a plausible bad-case scenario—disruptions in Algeria’s oil supply, for example—the price could even reach $140 or $150 per barrel over an extended period, enough to cut a percent or more from world growth. The panelists agreed that estimates are more likely to undershoot than overshoot the realized oil price.
- Political Worries: From a political standpoint, Yemen and Bahrain are the biggest concerns and could spell trouble for oil markets—the first through transport obstructions and the second through its proximity to Saudi Arabia, explained Boucek. Regional tensions could ignite fears that Iran blocks the Strait of Hormuz, though, as Webster noted, Iran depends vitally on the Strait for transporting oil. Boucek added that some of the region’s players, such as al-Qaeda, have a history of attacking oil infrastructure.
- Macroeconomic Implications: Timmer noted that any increase in the oil price will be harmful. For every 50 percent increase in the oil price, global economic growth will diminish by 1.5 percent. This will prove particularly difficult for high-income countries, which are already growing at lower rates than emerging economies, and especially for Euro area countries already facing debt crises. Headline inflation could also spiral and encourage premature monetary tightening, particularly in developing countries, which could have secondary effects on financial markets. Most dangerously, a higher oil price could hurt production capacity and lead to another recession, Timmer warned.
- Poverty and Employment: In addition, the higher price of oil and their spillover onto food could push millions of people into deeper poverty, said Timmer. Khan predicted that employment in high-income countries would also suffer significantly.
Panelists agreed that demand for oil is likely to rise rapidly and perhaps outpace supply over the next three to four years even without accounting for supply disruption in the Middle East.
- Demand from Asia: Though China’s most recent Five Year Plan aims to lower its oil consumption, Khan argued that both China and India will grow as oil markets as they build up their strategic oil reserves. Meanwhile, the damage done to Japan’s Fukushima nuclear plants by the recent earthquake and subsequent tsunami could turn the entire discussion of nuclear power on its head, reducing the likelihood that nuclear energy’s role as an alternative to oil increases. Timmer suggested that general energy and climate policy will affect oil prices.
- The Middle East: Khan suggested that developments in the Middle East will be particularly interesting to watch. He predicted a rise in populism in the region, with expansionary government policy to provide more jobs and food and fuel subsidies to citizens. Timmer agreed that the changes will be very important, as stability will emerge only when unemployment in the region is addressed. Webster suggested that Saudi Arabia, which uses crude oil for power, could become an even larger oil consumer in the future.
- Supply: Webster noted that Iraq’s oil production will likely increase, particularly in the short run, though he predicted protests could escalate in August and potentially offset the oil supply growth. Khan added that there is a need to set up more refineries capable of processing heavy Saudi oil to ensure that its unused supply capacity is effective in moderating incipient price pressures.
There is very little that the major economies can do to affect the oil market in the short term, but they can change the game in the long term by lowering their reliance on fossil fuels and instituting carbon taxes.
- Strategic Oil Reserves: The release of oil reserves to lower prices is unlikely, stated Khan. Most countries are actually moving in the opposite direction and building reserves. In addition, Webster argued that releasing reserves would likely have little impact—prices are not reflecting a lack of oil supply but rather a host of political and economic concerns.
- What Not to Do: Timmer noted that countries should refrain from decreasing gas taxes, subsidizing energy use to protect their own economies, or portraying climate change policy as only a long-term solution. Because oil markets are very forward-looking, announcing bold, realistic policies to mitigate climate change could dampen oil price pressures in the short term.
This event was the first in a two-part series on commodity prices and their broader implications. The second event, on April 6, will look at rising food prices.