The price of Brent crude oil, the international benchmark, hit $125 per barrel on March 7. It is the highest point since 2012. It is caused by the Russia’s invasion of Ukraine. Now, the price is about double what it was before the COVID-19 pandemic as well as six times above its low point in April 2020. During the Iran-Iraq war, between 1979 and 1981, the price of imported oil in the US is almost doubled. The price had also spiked a few years before that, when oil-exporting countries in the Middle East cut off deliveries to the US and other nations who were supporting Israel in a war against Egypt.
Demand rebounds quickly once conservation mandates relax. As geopolitical tensions eased in the 1970s, US public support evaporated for more ambitious fuel standards, or higher gas taxes which would have incentivized fuel conservation and innovation in alternative technologies, but kept gas prices elevated. The highest oil prices since the 2008 financial crisis are dealing a heavy blow to the global economy, slowing Europe’s pandemic recovery to a near stall and complicating the fight against inflation in the United States.
China, the world’s largest oil importer, will probably strain to reach this year’s economic growth target, while developing countries in North Africa and the Middle East confront the danger of social unrest over rising energy and food costs.
Impact of Russian Interruptions
The interruption of Russian oil shipments, including the US import ban that President Biden announced last week, represents one of the largest supply disruptions since World War II. With other major oil producers unable or unwilling to increase output in the short run, the per-barrel price of Brent crude, hit $128 earlier this week, which is 65% higher since Jan. 1.
Rising oil prices effectively redistribute income from oil-consuming nations in Europe and China to producers such as Saudi Arabia, Russia and Canada. As a group, producing nations spend less of each additional dollar than do consuming countries, meaning higher oil prices tend to reduce overall economic activity, Shearing said. The price jump since Jan. 1, would transfer more than $1 trillion from consumers to producers. And that figure does not include petroleum products such as diesel, gasoline or fuel oil. Drivers fumed this week when the average price of a gallon of gasoline surged to a record $4.32. But the shale oil revolution has made the United States one of the world’s largest oil producers, so higher prices boost oil company profits and investor returns. One oil stock index has gained 29% this year while the broader S&P 500 fell by more than 11 percent.
It would take oil prices of $200-plus to trigger a US recession. One reason is that US households together have an ample $2.5 trillion savings cushion, dwarfing the estimated $150 billion to $200 billion cost to consumers of higher pump prices. Though Russia accounts for just 2% of the world economy, it is a major player in global energy markets. Russian wells supply 11% of global oil consumption and 17 percent of natural gas usage. Russian gas pipelines are critical to Europe’s economy, meeting 40% of European needs. Russian oil flows to refineries in Poland, Germany, Hungary and Slovakia. As a result, the hit to growth from higher oil and gas prices will be four times larger in Europe than in the United States. For now, continued growth in the United States, China and India should be enough for the global economy to avoid an outright recession.
Predicting the future of Russian oil sales and global prices is especially hazardous. If US allies in Europe overcome their economic worries and agree to a complete embargo on Russian energy, oil prices could hit $160 a barrel.
Till today, the United Kingdom has said it will dissuade itself from Russian oil imports by year’s end. The European Union announced a plan to cut its Russian gas purchases by two-thirds before 2030 and said it will take unspecified steps to eliminate oil and coal buys as well. Even without additional government action, traders at companies like France’s Total Energies are shunning Russian crude.
This “self-sanctioning” could idle 3 million to 4 million barrels a day of Russian oil, roughly 70 percent of the country’s total crude exports. Keeping that much supply off the market could add $25 to the cost of a barrel of oil. Oil prices, which hovered around $65 a barrel in early 2020, traced an extraordinary arc over the past two years. There is little prospect of easily replacing lost Russian barrels. A resumption of Iranian exports is stalled by Moscow’s demand that its trade with Tehran be exempted from allied financial sanctions. Venezuela’s dilapidated facilities would need to be refurbished before they could fill the void.
Central banks traditionally resist reacting to oil price movements, seeing them as a temporary influence on price levels. But with U.S. inflation at a 40-year high of 7.9 percent, and labor market conditions tight, the Fed is almost certain next week to raise its benchmark lending rate by a quarter point.
Higher oil prices could cause the Federal Reserve to move less aggressively on its rate-hike campaign. At current levels, oil prices could cut a full percentage point off economic growth rates in major oil-importing countries such as China, Indonesia, South Africa and Turkey, according to World Bank estimates. For South Africa and Turkey, that would slash prewar growth estimates in half, while China and Indonesia would see projected growth drop to about 4 percent.
Governments in countries like Jordan, Lebanon and Tunisia, which protect consumers by subsidizing electricity prices, will struggle to afford those escalating costs. In January the efforts to reduce fuel and utility subsidies.
Steps required to lower prices
President Biden wanted to release millions of barrels of oil from the US Strategic Petroleum Reserve, which has a capacity of 727 million barrels. However, experts say that is unlikely to move the needle very much on the price of gasoline. The administration also has held talks, or said it plans to do so, with major oil producers such as Venezuela, Iran and Saudi Arabia about potentially boosting production. Some Democrats, meanwhile, are pushing to suspend the federal gasoline tax, which amounts to 18 cents a gallon, for the rest of 2022.
Yes, though those effects are typically long-term. Oil prices are set on global markets and are largely a factor of supply and demand. Germany’s government, for instance, decided to shift away from nuclear power after the Fukushima nuclear disaster in Japan in 2011. That meant it needed to produce more power from coal and natural gas, making it reliant on gas shipments from Russia.
Affect on inflation
US inflation rose to a 7.9% annual rate in February, according to Labor Department data. Gasoline prices, meanwhile, were up a seasonally adjusted 6.6% from the previous month, representing an unadjusted annual increase of 38%.
Rising gas prices—and commodity prices generally—are making a difficult job even harder for Federal Reserve officials, who are aiming to slow already hot inflation without hurting the economic recovery. A key question now facing investors and Fed officials is whether rising energy prices will add to or subtract from inflation in the medium term.
In contrast to the pre-pandemic economy, many households now are flush with cash, making it easier to absorb higher gas prices. In addition, the labor market is tight, giving workers more bargaining power.
Impact on Pakistan’s economy
Although the escalating geopolitical tension between Russia and Ukraine is thousands of miles away from Pakistan, its economic fallout has started spilling over into the geographical boundaries of Pakistan as well. Pakistan has already been buffeted by the risk of war, as local prices for gasoline, food, commodities, steel, and semiconductor chips are witnessing a sharp increase. While Pakistan is on the path of recovery from the covid-19 pandemic, the ongoing geopolitical tensions are likely to result in a general price increase, deteriorating current account and fiscal balances, and the stifling of economic growth.
Historically, Pakistan has had modest bilateral economic ties with both Russia and Ukraine in the past. In 2021, the value of trade with Russia was $711 million including $537 million in imports from Russia. Similarly, bilateral trade between Pakistan and Ukraine was valued at $800 million in 2021, with Pakistan receiving $739 million in imports. On the face of it, the conflict has already shaken economies across the world in numerous ways. For instance, sanctions imposed by the United States and Europe on Russia are likely to disrupt energy supplies from the world’s largest supplier. As a result of which, the energy prices have already soared to over seven-year highs. After spiraling as high as $101.95, the Brent crude futures contract lost $1.15 or 1.2 % at close at $97.93 a barrel. This is a major setback for an oil-importing country like Pakistan, as the commodity accounts for a sizable share of its imports. According to analysts, a $10-20 per barrel increase in oil prices over a few quarters is projected to deplete our national reserves by $1-2 billion, thus further shrinking the country’s purchasing power.
The impact of the crisis on the prices of oil, gas, and other supplies is a grave concern. Inflation in Pakistan has already surpassed a two-year high of around 10 percent, placing strain on the government combating on multiple economic and social fronts. This will further aggravate the inflationary pressure and hit the consumers badly, resulting in the rise of poverty and discontinuity in economic policies.
[box type=”note” align=”” class=”” width=””]The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Shaikh could be reached at nazir_shaikh86@hotmail.com.[/box]