Tuesday, March 18, 2008

Oil Politics 4: Is Expensive Oil Good for the World Economy?

One blogger asked, "could there be a danger for a bubble burst if oil prices dramatically and suddenly decreased given the current economic woes and enviromental concerns?"

I think world oil prices are heading north more than head towards the south. The trend is there: investors with lots of cash who are afraid to put their money in the banks because they don't know who will follow next to Bear Stearns, so they park their money in oil, gold, silver, other commodities. Here, they are assured of protection from high inflation and good returns, at least in the next few months.

Besides, with more globalization, more people around the world are working harder, they move more often, and use more petroleum or oil-substitutes more often.

So, is expensive oil good for the world economy? In a sense, Yes. The volume of cars and trucks on the roads, the boats and ships on the seas, and airplanes on the skies, will remain the same if not become plentier. But with higher oil prices, only more essential and more productive trips are made; the less essential and frivolous trips are postponed and substituted by online communications.

What about the poorer sectors and people of the world? Expensive oil will hurt them, true. But so will cheap oil in the form of "over-consumption" of the commodity, which leads to more traffic congestion, more pollution, more diseases, and less investments and R&D to fuel-efficient cars, "green" energy alternatives.

Meanwhile, the world is now getting accustomed to 3-digit oil prices. After the symbolic $100 a barrel has been reached about 2 months ago, the next "target" was the all-time high price of $103.7 a barrel, which was the current equivalent value of the $30+ touched in 1980 during the Iran hostage crisis. This week, the $110 has been touched, and as the trend continues, a $115 a barrel or higher, may not be too far.

The net gainers of these are the oil exporting countries (OPEC or non-OPEC members) of course, plus the speculators who make big profit margins with the continuing oil price spikes. They just collect higher revenues for the same volume of oil they sell and export. Prices of gold (has already touched the symbolic 4-digit level of $1,000 an ounce), silver, rice, wheat, many other commodities are rising anyway, so must oil.

If economies are generally competitive and there is easier entry and exit (near "contestable market" condition) for firms, high prices will attract new entrants and producers, either of the same goods or substitute goods. As oil prices continue to rise, the more profitable will be the “alternative energy” sectors, from windmills to solar to biofuels, etc.

On a related note, I posted this last February 28, 2008.

Inflation in oil exporting countries

As world oil prices tend to stabilize around the $100/barrel price, inflationary pressure building up in many oil-importing countries is understandable. But when the same pressure builds up in oil-exporting countries themselves, it's a little bit of news.

Well, not exactly. With so much money made from selling ever more expensive oil, inflation will surely happen in many oil-exporting countries -- if the supply of goods and services needed in those countries do not correspondingly increase. Remember that price increases only when the growth of supply of certain goods and/or services do not rise correspondingly with growth in demand.

More imports and trade liberalization, including increased inflow of workers and professionals from other countries who provide the services needed by the local people, will help tame inflationary pressures. For instance, if more Arab people will demand more modern health services, and if the number of healthcare facilities (clinics and hospitals, health laboratories, etc.) and health professionals do not expand, then those rich Arabs will flock to existing facilities and health professionals and crowd out their poorer countrymen and expats, resulting in high inflation in the health industry.

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