Record global oil prices exacerbated by emerging economies

Sherine El Madany
7 Min Read

As oil prices continue to shoot to new records breaking a heady $127 a barrel last week before edging back slightly, Egypt – a country not cushioned by oil wealth – is left wrestling with soaring energy and food bills.

Crude oil prices account for over half the cost of gasoline at the pump, weighing on several Egyptians as the cost of many goods, including most foodstuffs, has risen as it becomes pricier to make and ship them.

Robust demand for crude and a weak dollar, analysts say, have fuelled the rally from a dip below $50 at the start of 2007. Oil prices have gone up nearly 25 percent since the start of 2008.

Crude oil prices have surged more than five-fold since 2002 amid surging demand from China and other emerging economies.

Mohamed Abu Basha, economist at the Egypt-based regional investment bank EFG-Hermes, explained that demand from fast-growing economies in Asia and the Middle East is one of the main drivers of the current rally.

“Countries like China, India, Russia, and other developing nations have seen high growth rates, which in turn increases demand for oil.

Although global demand on oil has slowed after a surge in 2004, it is still rising and higher prices have so far had a limited effect on most country’s economic growth.

“Another main reason for the new record highs is a lack of new refining capacity and major oil consuming countries such as the US are helping fuel the rise in prices, Abu Basha added.

Recent data shows that US refinery utilization is currently about 85 percent – levels not seen since October 2005 after hurricanes Katrina and Rita shut down Gulf Coast refineries. Investment in new plants has been slowed as rising costs and a shortage of engineers delay construction.

“Supply disruptions in oil producer Nigeria have also helped push oil to new peaks, Abu Basha pointed out. Strikes and attacks by militants on oil installations have caused a succession of supply problems in the world s eighth-largest oil exporter. About 564,000 barrels per day (bpd) of Nigeria’s crude oil production has been cut since February 2006 due to militant attacks on the country s oil industry.

Exxon Mobil said last April it had declared force majeure on its Nigerian shipments after essentially all its roughly 800,000 bpd of crude production was shut because of an eight-day strike which had shut in virtually all the US oil major s production in Nigeria. The company later said it restored some of its Nigerian crude oil production, with current levels at approximately 300,000 bpd and increasing. Royal Dutch Shell s production from Nigeria is also down by about 164,000 bpd.

Another strike over pensions at the Grangemouth refinery in Scotland closed early in the month the 700,000 bpd Forties pipeline, which produces half of the UK’s oil output.

“There are other less fundamental causes that add to the ongoing oil price spikes such as threats on Iran [the world’s fourth largest oil producer] as well as the weakness of the dollar, Abu Basha said.

The fall in the value of the dollar against other major currencies has triggered buying across commodities such as oil as a hedge against inflation when the greenback falls. A weaker dollar also makes oil cheaper for overseas buyers.

“A bomb attack on a pipeline in Iraq also affected its exports, again hiking prices, he added.

Further propelling the rally on oil prices was a decision in late 2006 by the Organization of the Petroleum Exporting Countries (OPEC) – source of more than a third of the world s oil – to reduce oil output in a bid to stem a fall in prices. Consequently, consumer nations led by the International Energy Agency have urged OPEC to pump more oil and bring prices down.

The relentless surge in oil prices has got Egypt, a non-major oil exporter, trapped in a wave of soaring prices across several commodities, particularly foodstuffs. According to the state statistics agency CAPMAS, food prices surged 22 percent in the year to April, which caused urban inflation in Egypt to jump to a fresh three-year peak. Consumer Price Index rose to 16.4 percent in the year to April, from 14.4 percent in the year to March.

The rise in inflation – mainly fueled by the ongoing rise in oil prices – has added pressure on the Egyptian government, which has to weigh the fiscal costs of subsidizing fuel and food against public discontent.

“A constant rise in oil prices directly reflects on the state budget and on energy subsidies. Energy subsidies will rise to some LE 63 billion in the 2008/9 fiscal year from LE 57 billion this fiscal year that ends in June, Abu Basha explained. “Last year, energy subsidies were at around LE 30 billion.

Initially this year, they were supposed to be at LE 39 billion, but the hike in oil prices weighed on the budget.

Similarly, the cost of food subsidies will grow to LE 20 billion from LE 15 billion this year, which ends on June 30.

Unable to meet the cost of rising oil prices, Egypt introduced steep increases in gasoline early May, sending diesel, kerosene, and high-octane fuel prices up 35-45 percent.

But a global economic slowdown – triggered by the US credit crunch – could propel crude oil out of its current record levels, as global demand eases off, experts say.

The slowdown in the US economy coupled with a slowdown in European, Chinese, and Indian economies, Abu Basha clarified, could pull oil demand down and consequently lead to a decline in global prices.

“Oil prices could mildly go down in the short-term, but it will not be a sharp fall compared to its sharp increase last year, Abu Basha said. “Prices will not be lower than $90 a barrel at least this year. They will not fall to the year 2007’s $60 and $70 a barrel.

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