Danger of rising Oil prices from the macroeconomic point of view

1. Threats for the World Economy:
The Danger of Rising Oil Prices
Sherif Mohamed
Katharina Jungblut
28 June 2011

2. The Rise of Oil Producing Industry
1859: Colonel Edwin L. Drake and George Bissell
with first drilling rig to produce oil in Titusville, Pennsylvania

3. The Ubiquity of Oil Today
Kerosene
Make-up Gasoline
Diesel
Medicine
Fuel
Food Heating
Additives Oil
Crude
Oil
Fertilizers
Jet Fuel
Pesticides
Synthetic Heavy Oil
Fibers Fuel
Bunker
Plastics
Fuel

4. Global Oil Consumption Today
Global oil consumption per capita
(tonnes of oil equivalents)
Source: worldpress.com, ecoglobe.ch (2007)

5. Growing Global Oil Consumption
• IEA’s forecast for global oil demand
in 2011: 89 mbpd
Source: IEA; businessinsider.com (2010)

6. Historical Development of Nominal Oil Price
Source: IEA (2009)

7. Traditional Market Theory
• Free and competitive market
• Forces of supply and demand
• Equilibrium price

8. Reality of Oil prices
• Change permanently in hardly predictable ways
• Influenced by various determinants at different
times

9. Demand Growth in Emerging Countries
Advanced OECD countries account for
more than half of global oil
consumption
Demand of emerging countries is
increasing at a far greater pace
China‘s CAGR of demand: 7% between
1990 and 2010
Price elasticity of demand fairly low

10. Demand Growth in Emerging Countries
Source: IEA (2010)

11. Speculation on Futures Markets
Speculators with short-term profit oriended
focus
Institutional investors hedge against future price
risks
Expectations exert upward pressure short- and
mid-term real prices
Tendency to „overshoot“

12. Speculation on Futures Markets
•January 2011: net long positions on crude oil hit their highest point in four years
• April 2011: Speculators keep up bets that crude and heating oil prices will rise
Source: Reuters (2011)

13. The Power of OPEC
Organization of the Petroleum Exporting Countries
about 40% of about 55% of 2/3 of global
global supply global exports reserves
Non-OPEC production has stagnated since 2004
Increase in global supply attributable to OPEC countries
Strength of OPEC has increased since the 1990s
Specific threat from geopolitical tensions raises precautionary demand

14. The Power of OPEC
Organization of the Petroleum Exporting Countries
2007: Angola and Ecuador in
2009: Indonesia out
Source: OPEC(2006), IEA (2010)

15. The Power of OPEC
Organization of the Petroleum Exporting Countries
negative news about geopolitical tensions
• expected risk of short- to medium-term supply shocks
• increased precautionary demand
• greater price volatility
Source: IEA (2011)

16. Peak Oil Theory
World oil reserves are reaching peak production
capacity and start to shrink
Annual discoveries of crude oil declining since 1960s
Annual production exceeds annual discoveries since
1980s
So far, no clear-cut empirical evidence of scarcity rent
Issue is projected to gain considerable impact in the
future

17. Peak Oil Theory
Source: fraw.org (2008)

18. Determinants of Oil Prices
• No systematic explanantion
• Triggered by numerous and time-varying mechanisms of
demand- and supply-forces
• Suggested key features of future prices
Limited
Low price expansion of
elacticity production
of demand capacity
Demand growth in
emerging countries

19. Inflation
• Oil price shocks proven inflationary
• Sharp changes in inflation follow major oil price changes
• Correlation has weakened over time / even became negative

20. Inflation Transmission Mechanism
Inflation
Unchanged
real value of
Companies goods and
adjust prices services
Increase in
price of oil

21. Determinants of Proneness to Inflation
Oil-intensity of production
Percentage of oil imports vs. domestic oil
production
Strength of labor unions
Product market competition
Exchange rate movements

22. Decreasing Vulnerability to Inflation
• Declining oil intensity in the US since 1970s
• Diminishment of European trade unions‘ bargaining power
• Product market liberalization

23. Inflation outcomes
Effects predominantly No effects on core
80% of effect is immediate
short-run inflation since 1980s
• Impact of a 10% increase in oil prices

24. Fiscal and Monetary Policies
Dual effects of oil shocks
Decrease
Increase inflation
economic output
Dilemma for policymaking
Amplify
inflation Concentrate on reccessive effects, Aim at neutralizing effects on inflation
Lower interest rates, increase money supply Increase interest rates, restrict money supply
Reductions
in
economic
output

25. Inflaton Targeting
• Increasing independence of central
banks
• Prevailing adaption of price stability
objectives
• Anchor inflation expectations among
market participants
• Prevent temporary inflationary shocks
from becoming embedded in core
inflation

26. Conclusions
• Accumulated forces of demand and
implications of supply drive prices of oil
• Oil prices are highly volatile and overall
increasing
• Negative effects on economic stability and
growth
• Redundancies and sub-optimum allocation of
production factors
• Deterioration of purchasing power

27. Conclusions
• Large and energy-intensive countries are
• most vulnerable to oil price fluctuations
• Major drivers of global economic performance
• Monetary policies can eliminate a
considerable part of inflationary effects
• Trade-off between price stability and
economic growth hardly avoidable

28. Prospects
• Simulation: Oil price of $191 will result in 0%
global economic growth
• Yet, world has become less vulnerable to oil
price shocks over the past decades
• Economic and fiscal policies
• More efficient strategic management of resources
• Learning curves from past oil shocks

29. Prospects
• Rising oil prices
• A real and serious threat to global economy
• A unique challenge and opportunity for each national
economy to restructure, stabilize and invigorate