Cedric Wilson, Guest ColumnistWithin days of malevolent Hurricane Katrina stepping out of the Gulf of Mexico, creating mayhem, grief and tragedy in three of America's southern states, the price of oil jumped to over US$70 per barrel. And although it quickly retreated to the sub-US$70 zone after President Bush gave clearance for the release of oil from the federal petroleum reserves, it nonetheless fuelled further speculations as to whether the global economy may be on the brink of a recession.
Even before the hurricane, the sheer pace and level of the increase in oil prices was a matter of concern among economists. Indeed, all of the last three global recessions were triggered by dramatic increases in oil prices. And after all, the price of oil had peaked at US$67 per barrel, just before the hurricane, whereas the average price in 2001 was US$23. The recession of 1973-74 was caused by the OPEC oil embargo which decisively put an end to the era of cheap oil. The 1978-80 global contraction was a direct result of the Iranian revolution which saw the toppling of a secular regime and the installation of an Islamic order. The 1989-90 meltdown occurred after President Saddam Hussein of Iraq invaded Kuwait. In all these cases, there were significant jumps in oil prices.
increases fuelled by demand
However, it has been argued that global economy is not quite ready for a recession because the underlying reason for the movement in oil prices is fundamentally different. In the last three recessions, price hikes were driven by interruptions in supply. On the other hand, ruling out the impact of Katrina on the oil refining capacity in the gulf coast, the increases in oil, prices are being fuelled by demand.
Over the last couple of years China, and India to a lesser degree, have registered impressive economic growth. Relative to last year, the Chinese economy has grown by 9.5 per cent while India experienced a seven per cent growth. Both have placed considerable pressure on the international oil market. However, it is China that is responsible for the lion's share of the demand. The scale and scope of China's industrialisation and the changing taste pattern of a newly emerging middle class has moved it from a net exporter to a net importer of oil. Last year China alone accounted for one third the growth in global oil consumption. In recent times, China's growth in oil consumption has been estimated at roughly seven times faster than the U.S. growth in oil consumption. In fact, it has been projected that based on current trends, China's consumption of oil will be 150 per cent more than the present level by 2020.
delicate dynamics
It is, therefore, reasonable to believe that a global recession is not on the horizon. Yet, it would be simplistic and unforgivable for governments in small vulnerable economies, like Jamaica, to be complacent. In the first place, the dynamics on the international oil market are very delicate. Over the last decade, very little emphasis
has been placed on oil exploration, development and refinery expansion. As a result, the output capacity for oil is practically equivalent to demand. Any interruption in supply, as seen with damage inflicted by Katrina on the refining capability in the U.S. Gulf, could send oil prices soaring beyond what is even sane to imagine. It could be a strategic terrorist attack, a major accident at a key oil facility, an earthquake, a war God forbid but the situation is fragile.
The position of the Jamaican economy is delicate, since virtually all of our energy needs are met by imported fuel. Therefore, even without a major interruption in the supply of oil, if the demand continues to grow at the same pace, unless we can quickly find a way of increasing our export earnings, the Bank of Jamaica will have a difficult job maintaining stability in the foreign exchange market even with the current healthy stock of net international reserves. Our recent history has shown that confidence in the economy appears to be tied more closely to exchange rate stability than any other economic variable.
important development
The PetroCaribe deal with Venezuela is an important development but it must be stressed that it will not have an impact on oil prices in Jamaica. It allows Jamaica to buy oil from Venezuela at market price. However, oil payments are converted into a loan payable over 25 years at an interest rate of one per cent. Certainly, among other things, this will help the Government with its cash flow and provide an opportunity for the refinancing of more expensive loans but the price at the gas pumps and on our electricity bills will not be any lower.
The only hope for lower energy prices that may be on the horizon is the liquefied natural gas (LNG) deal being worked on between the Jamaican Government and its counterpart in Trinidad. This would see Jamaica being supplied with LNG at prices fixed in real terms over 20 years. Much work has to be done to seal this deal from the realms of an idea to concrete reality. In any case, a back-up plan is needed. Therefore, in the face of fragility of the international oil market, it is imperative that a national plan encompassing energy conservation and exports, be developed to address the inevitability of an upward trend in oil prices.
Cedric Wilson is an economist specialising in market regulation. He can be contacted at conoswil@hotmail.com.
