CHAPTER NINE: How Globalization Works in Practice

Using the Perspectives

July 1, 2008. "Thirst for oil will keep prices high." Scotsman
http://business.scotsman.com/economics/Thirst-for-oil-will-keep.4210496.jp

The following article by Thorsten Fischer, senior economic adviser at Royal Bank of Scotland, discusses a number of factors that affect world oil prices ....a physical shortage not being one of them. Read the article below and take note of the domestic and international factors that play a role in oil prices.

Fischer notes that despite declining output of oil we see increasing consumption. One reason for this is that in many countries oil is subsidized which erodes incentives to cut consumption. Moreover he notes that despite considerable reserves in US oil companies are severely restricted in tapping new drilling opportunities. Moreover OPEC has declined to increase ouput. Fischer writes, "Opec, which still controls the lion's share of proven reserves, has proven reluctant to boost production or capacity. Restricting supply means higher prices. National oil companies (NOCs) are reasserting themselves, as high oil prices have shifted the balance of power."

He continues, "The issue is not a physical shortage of oil - there is plenty of oil in the ground - but a shortfall of investment because of resurging resource nationalism and geopolitical instability. As a result, capacity will remain well below the level that would be achieved in a competitive and developed market given current high prices."

1.  How does U.S. policy affect world oil prices? Why do you think the United States restricts oil production?
     

2.  Why would OPEC want to restrict production? Whose interests does OPEC represent?
     

Development in emerging markets has contributed to rising oil prices. In 2007, global demand for oil increased by one million barrels per day. As poor countries become more well off they increase energy-intensive activities. Included in these developing countries are countries like Saudi Arabia in the resource-rich Middle East.

While normally high oil prices should reduce consumption, subsidy programs in these developing countries prevent this from occurring. "About a quarter of global retail fuel sales are subsidized, mainly in emerging markets. This means that there is little incentive for businesses and consumers to curtail consumption. That said, China has just increased retail fuel prices by 18%-25%. Subsidized petrol and diesel led to heavy losses for refiners and to domestic fuel shortages. These increases will have a significant effect on demand, even if fuel prices remain well below the global level.

Fischer argues however that the burden of adjustment should fall not on emerging markets in developing countries but by the comparatively-rich developed countries. "Indeed, high prices have already started to curtail consumption (where market forces are allowed to work). In the US, demand growth turned negative for the first time in 17 years. It is down 1% for the first half of 2008. Other OECD countries have seen even stronger responses: consumption fell 2.6% in the EU, 3.5% in Japan and 9% in Germany in 2007. In contrast, China's consumption increased by 4.1%. . . ."

3.  What does it mean to say that fuel sales are "subsidized?" What type of policy is this?
     

4.  How has subsidizing fuel helped developing countries? How has it hurt other countries?
     

5.  In your opinion, what should be done domestically to manage oil prices? What should be done internationally?