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World: Oil Price Rise Threatens To Nip Economic Recovery In The Bud

  • Mark Baker --> Oil prices are rising -- and that's potentially bad news for oil consumers like the United States, the European Union, and Japan. They had been expected to lead the global economic recovery this year, but that rebound is now threatened. Oil producers are seeing a short-term windfall, but they too have a long-term interest in price stability. RFE/RL looks at why oil prices are rising and what effect higher prices will have.

Prague, 12 May 2004 (RFE/RL) -- Concerns are growing that rising oil prices could derail the global economic recovery.

Oil prices this week rose to over $40 a barrel, their highest in 13 years. The rise was fueled in part by uncertainties in the Middle East and Iraq -- but also by higher demand from rapidly growing economies in China and India. That demand will increase in coming weeks as the Northern Hemisphere enters the summer travel season.

The world economy -- led by the United States, the European Union, and Japan -- had been expected to rebound this year after several years of slow or no growth. But economists say the recovery may be in danger if oil prices rise too high too fast.

Mohammed Ali-Zainy, a senior energy economist at the London-based Center for Global Energy Studies, told RFE/RL: "[The] economy in the world is recovering. It is growing at a good rate. However, we know that higher prices of oil would affect the economy negatively in the sense that it would reduce the growth potential of oil-importing countries. In this manner it would contribute to inflation, budget deficits, and also to rising unemployment."

Higher oil prices typically affect economies in several ways. Higher prices cut directly into consumers' and companies' incomes, leaving them with less money to spend on other goods and services. Higher oil prices also contribute to inflation or at least the perception of inflation, which leads central banks to raise interest rates to dampen price pressures. This, in turn, reduces borrowing and investment.

Memories are still vivid in the United States and Western Europe of the oil-price shocks of the 1970s, when rapid rises in oil prices sent inflation and interest rates soaring and cut into economic growth for nearly a decade.

The Paris-based Organization for Economic Cooperation and Development (OECD) recently announced a relatively optimistic forecast for economic growth this year. But the group's chief economist, Jean-Philippe Cotis, cautioned that scenario was based on an assumed oil price of $32 a barrel -- a full 20 percent lower than current prices.

Ali-Zainy says the recent run-up in prices can be attributed to essentially two factors: "One of them is the low commercial stocks [of fuel] in the world, notably product stocks in the United States -- that is, [stocks of] gasoline in the United States. Secondly, there is a geo-political [reason] in the sense that there is unrest in the Middle East and terrorist attacks -- and there is a fear of disruption of supplies, especially from Saudi Arabia."

Pressure is now increasing on oil producers to increase production levels in the short term. Saudi Oil Minister Ali Naimi this week suggested the OPEC oil cartel could temporarily raise its production ceiling to 25 million barrels a day -- from 23.5 million -- to ease price pressures. This, however, was widely viewed as a symbolic since OPEC already produces about 2 million barrels a day more than its production ceiling.

In general, oil producers have a strong interest in keeping prices relatively stable and reasonable. While the higher prices mean more money in the short term, in the longer term, the economic damage on consumer countries can lead to a drop in demand for oil. Higher oil prices also encourage consumers to develop alternative energy sources. This is the last thing OPEC wants.

On the other hand, for Saudi Arabia and other oil producers, any move to quickly increase production also entails risks. Oil supply is highly volatile and any hint of an oversupply can lead to a rapid collapse in prices.

The higher oil prices will be welcomed in non-OPEC producer states like Russia, Kazakhstan, and Azerbaijan. These countries are already among the fastest-growing economies in the world.

The European Bank for Reconstruction and Development (EBRD) says growth in all three could reach as high as 8 percent this year, based largely on higher energy prices. In Azerbaijan alone, the oil and gas sector accounts for around a third of all economic activity.

The trend toward higher oil demand is expected to continue. The Paris-based International Energy Agency (IAE) recently raised its estimate of world demand for oil to 80 million barrels a day -- a rise of 2 million barrels a day from 2003. The agency said the increase was driven largely by China, where demand for oil grew by one million barrels a day in the first quarter of the year and is expected to rise faster in the second quarter.

The IAE, in its monthly oil report, called on oil producers to invest more in infrastructure to increase output.