On February 24, the benchmark price of a barrel of Brent oil reached US$119.79 — the highest level since 2008 — as a result of growing concerns that uprisings in Libya could lead to similar troubles in other major crude oil producing countries in the Near East, such as Saudi Arabia. As recently as last September, Brent crude was selling for only $80 a barrel.
“Generally speaking, we still don’t know what the impact of rising oil prices will be,” says Federico Steinberg, chief researcher of economics and international trade at the Real Instituto Elcano, and professor of economic analysis at the Autonomous University of Madrid. “We’ll have to wait to see if there are any ‘second round’ effects — that is to say, if companies suffer from rising production costs as a result of the rising price of crude, and then increase the prices of the products they provide to consumers.” If this were to occur, he notes, “workers would demand salary increases, and we would enter an inflationary spiral.”
An Uneasy Market
The extreme uneasiness in the oil market began with the outbreak of the social revolt in Tunisia that overturned the Ben Ali regime. On that day, Brent was selling for US$95 a barrel. The wave of protests spread to Egypt and then into Libya. It was the revolution in Libya that did the most to push up the price of crude, because of fears that petroleum production would be entirely shut off as a result. Libya produced 1.57 million barrels per day in January, according to the Organization for Petroleum Exporting Countries (OPEC) and the International Energy Agency (IEA) — a figure that represented 1.8% of the world’s total production that month.
The real fear in the market is that the protests will also spread to Saudi Arabia, the world’s largest petroleum producer, which pumped 8.34 million barrels per day in January. “Discounting an interruption of supply from Libya is one thing, but it is something very different if the revolt expands into Saudi Arabia, which has 20% of the world’s petroleum output,” David Rosenberg, strategist at Gluskin Sheff, told Bloomberg News on February 24.
West Texas oil futures, the reference price for petroleum in the United States, reached US$105.17 a barrel on March 4, the highest price since September 2008. In September 2010, the price was only $73.
“Oil prices above $100 a barrel are bad news for the economic recovery of the member-nations of the OECD (Organization for Economic Cooperation and Development), as the IEA has already said,” notes Mariano Marzo Carpio, professor of energy resources in the geology department of the University of Barcelona. “High fuel prices mean more inflation and lower purchasing power for consumers.” He adds: “All of that will be combated by raising interest rates, which will mean more expensive money for companies, which may suffer by being able to invest less — and the higher cost of money will have a [negative] impact on consumer loans. We find ourselves in a situation where there are prospects for higher inflation and lower economic growth, the worst possible situation that economies can face.”
According to Rafael Pampillón, professor of economics and country analysis at the IE Business School, “Clearly, the rising price of oil does nothing good for the global economy.” On the contrary, he notes, “it has a negative impact on every economy of the world, as we’ve seen from the fact that the European Central Bank has already warned that it could raise interest rates at its meeting in April. This is a threat that we had foreseen for November.”
Higher Euro Zone Rates
At its latest monthly meeting on March 3, the European Central Bank (ECB) decided to maintain interest rates at 1%, the same level since May 2009. Nevertheless, ECB president Jean-Claude Trichet acknowledged at a press conference that rates could go up in April, when the ECB holds its next meeting. However, he said there was no reason why this should be the beginning of a series of interest rate hikes. The French banker explained that he is more concerned about persistent inflation than he had expected to be because of the rising price of petroleum. Trichet made it clear that the ECB’s governing council “is prepared to act” with the goal of avoiding inflationary pressures if they materialize, and it is maintaining its “strong vigilance” over prices.
The Consumer Price Index in the euro zone accelerated again in February, reaching a pace of 2.4%, year-on-year, after 2.3% in January, according to a report issued by Eurostat, the European statistical agency, in March. The main reason for the increase was higher prices for energy and primary products. The goal of the ECB is to maintain inflation below a year-on-year rate of 2%.
“There could be a big problem if the increased inflation comes very suddenly, because economies would not be able to adapt and they could suffer,” says Steinberg. “It will also be important to see if this is [just] a temporary shock in the price of petroleum or a permanent one.” For Steinberg, the troublesome thing about rising interest rates is that they “dampen economic growth.” Nevertheless, he believes that “the crisis of the 1970s taught us that increased expectations about inflation are very dangerous, so central banks are not going to permit this to occur.” He recalls that “the ECB has shown that it is more decisive about raising interest rates [now], but the U.S. Federal Reserve Bank has treated inflation as less important [than other factors]; [the Fed] is more concerned about economic activity and employment [than about inflation].”
Pampillón warns that if rising interest rates ultimately materialize in Europe, the euro will appreciate against all other currencies. “That would lead to a reduction in exports from those countries of the [euro zone] region because their products would lose competitiveness.” He adds, “Germany might be one of the countries that are hurt the most by the higher value of the euro because its economy depends a lot on exports, and they would be held back. If the largest economy of the euro zone [Germany] loses strength, this will affect the other economies in the region, such as Spain, that export many of their products.” In addition, given the current economic environment, in which there are so many unanswered questions, “the sovereign risk of countries surrounding the euro zone can grow again. When there is increased uncertainty in the markets and aversion to risk, investors will once again demand higher interest rates if they are to buy public-sector debt.”
According to Marzo Carpio, “The higher price of petroleum is going to have a general impact on every country in the OECD, but it will have a particular impact on the countries of southern Europe, such as Portugal and Spain. Those countries have been emerging from the crisis more slowly, and they are being pressured by debt markets.”
The Impact on Latin America
The Economic recovery has not been uniform round the world, so the rising price of petroleum will not affect every region equally. Dominique Strauss-Kahn, managing director of the International Monetary Fund, acknowledged that on March 3, when he stated that growth is moving along “quite rapidly” in Asia and Latin America, but slowly in both Europe and the United States. “There is a double problem in this recovery taking place: First, there is the risk of overheating in the emerging countries; and second, there are the problems in North Africa and their impact on petroleum prices,” he said. Strauss-Kahn made these comments to the press after meeting with Brazilian government officials to discuss prospects for the global economy and Latin America.
Notes Steinberg, “In Latin America, rising petroleum prices affect various countries in different ways. For example, Venezuela, which is an exporter of crude oil, will think that the rising value of crude is something marvelous. Other countries won’t. Nevertheless, rising petroleum prices take place within a generalized increase in the prices of all primary products. Generally speaking, Latin American countries are exporters of primary products, so they could be favored by current market conditions. Latin America could be one of the regions for which the rising price of petroleum is most beneficial.”
Marzo Carpio has a different view. “Latin American countries will [ultimately] suffer from the increase in petroleum prices. Their populations will have to pay more for those primary products that are getting more expensive, and that will affect their economies. [Latin American countries] won’t be able to make up for [the higher domestic costs] just because they will be able to sell those goods at higher prices abroad.”
“Because they are exporters of raw materials, the generalized rise in prices in this market is favorable to Latin American countries,” Pampillón says. However, he adds that “while recovery in the most developed countries is restrained, demand for raw materials will be, too.” Beyond that, “South America will also suffer from some of the highest energy costs, which will also lead to higher interest rates, the appreciation of their currencies, and as a result, additional problems when they are exporting. You also have to recognize that the rising price of money will make it harder for companies to get loans for making investments — something that is also very negative for these countries.”
In the coming months, notes Pampillón, it will be very hard to predict what will happen with the price of petroleum. “Crude oil was already on an upward trend before the uprisings began in North Africa and the Middle East. Inflation was also moving higher. In any case, it is impossible to know how things will develop in these regions, where it is so hard to predict events and how those events will affect the price of crude.”