Tag: trade sanctions

Oil prices have been rising in recent weeks. With Brent crude currently at around $85 per barrel, some commentators are predicting the price could reach $100. At the beginning of the year, the price was $67 per barrel; in June last year it was $44. In January 2016, it reached a low of $26. But what has caused the price to increase?

On the demand side, the world economy has been growing relatively strongly. Over the past three years, global growth has averaged 3.5%. This has helped to offset the effects of more energy efficient technologies and the gradual shift away from oil to alternative sources of energy.

On the supply side, there have been growing constraints.

The predicted resurgence of shale oil production, after falls in both output and investment when oil prices were low in 2016, has failed to materialise as much as expected. The reason is that pipeline capacity is limited and there is very little scope for transporting more oil from the major US producing area – the Permian basin in West Texas and SE New Mexico. There are similar pipeline capacity constraints from Canadian shale fields. The problem is compounded by shortages of labour and various inputs.

But perhaps the most serious supply-side issue is the renewed sanctions on Iranian oil exports imposed by the Trump administration, due to come into force on 4 November. The USA is also putting pressure on other countries not to buy Iranian oil. Iran is the world’s third largest oil exporter.

Also, there has been continuing turmoil in the Venezuelan economy, where inflation is currently around 500 000 per cent and is expected to reach 1 million per cent by the end of the year. Consequently, the country’s oil output is down. Production has fallen by more than a third since 2016. Venezuela was the world’s third largest oil producer.

Winners and losers from high oil prices

The main gainers from high oil prices are the oil producing countries, such as Russia and Saudi Arabia. It will also encourage investment in oil exploration and new oil wells, and could help countries, such as Colombia, with potential that is considered underexploited. However, given that the main problem is a lack of supply, rather than a surge in demand, the gains will be more limited for those countries, such as the USA and Canada, suffering from supply constraints. Clearly there will be no gain for Iran.

In terms of losers, higher oil prices are likely to dampen global growth. If the oil price reaches $100 per barrel, global growth could be around 0.2 percentage points lower than had previously been forecast. In its latest World Economic Outlook, published on 8 October, the IMF has already downgraded its forecast growth for 2018 and 2019 to 3.7% from the 3.9% it forecast six months ago – and this forecast is based on the assumption that oil prices will be $69.38 a barrel in 2018 and $68.76 a barrel in 2019.

Clearly, the negative effect will be greater, the larger a country’s imports are as a percentage of its GDP. Countries that are particularly vulnerable to higher oil prices are the eurozone, Japan, China, India and most other Asian economies. Lower growth in these countries could have significant knock-on effects on other countries.

Consumers in advanced oil-importing countries would face higher fuel costs, accounting for an additional 0.3 per cent of household spending. Inflation could rise by as much as 1 percentage point.

The size of the effects depends on just how much oil prices rise and for how long. This depends on various demand- and supply-side factors, not least of which in the short term is speculation. Crucially, global political events, and especially US policies, will be the major driving factor in what happens.

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Data

Questions

  1. Draw a supply and demand diagram to illustrate what has been happening to oil prices in the past few weeks and what is likely to happen in the coming weeks.
  2. What is the significance of the price elasticity of demand and supply in determining the size of oil price increase?
  3. What determines (a) the price elasticity of demand for oil; (b) the income elasticity of demand for oil; (c) the price elasticity of supply of oil?
  4. Why might oil prices overshoot the equilibrium price that reflects changed demand and supply conditions?
  5. Use demand and supply diagrams to illustrate (a) the destabilising effects that speculation could have on oil prices; (b) a stabilising effect.
  6. What industries might gain from higher oil prices and why?
  7. What would OPEC’s best policy be in the current circumstances? Explain.

One of the reasons why it is so hard to forecast economic growth and other macroeconomic indicators is that economies can be affected by economic shocks. Sometimes the effects of shocks are large. The problem with shocks is that, by their very nature, they are unpredictable or hard to predict.

A case in point is the current crisis in Ukraine. First there was the uprising in Kiev, the ousting of President Yanukovich and the formation of a new government. Then there was the seizing of the Crimean parliament by gunmen loyal to Russia. The next day, Saturday March 1, President Putin won parliamentary approval to invade Ukraine and Russian forces took control of the Crimea.

On Monday 3 March, stock markets fell around the world. The biggest falls were in Russia (see chart). In other stock markets, the size of the falls was directly related to the closeness of trade ties with Russia. The next day, with a degree of calm descending on the Crimea and no imminent invasion by Russia of other eastern parts of Ukraine, stock markets rallied.

What will happen to countries’ economies depends on what happens as the events unfold. There could be a continuing uneasy peace, with the West effectively accepting, despite protests, the Russian control of the Crimea. But what if Russia invades eastern Ukraine and tries to annex it to Russia or promote its being run as a separate country? What if the West reacted strongly by sending in troops? What if the reaction were simply sanctions? That, of course would depend on the nature of those sanctions.

Some of the possibilities could have serious effects on the world economy and especially the Russian economy and the economies of those with strong economic ties to Russia, such as those European countries relying heavily on gas and oil imports from Russia through the pipeline network.

Economists are often criticised for poor forecasts. But when economic shocks can have large effects and when they are hard to predict by anyone, not just economists, then it is hardly surprising that economic forecasts are sometimes highly inaccurate.

What Wall Street is watching in Ukraine crisis USA Today (3/3/14)
Ukraine’s economic shock waves – magnitude uncertain Just Auto, Dave Leggett (7/3/14)
Ukraine: The end of the beginning? The Economist (8/3/14)
Russia will bow to economic pressure over Ukraine, so the EU must impose it The Guardian, Guy Verhofstadt (6/3/14)
Russia paying price for Ukraine crisis CNN Money, Mark Thompson (6/3/14)
Ukraine Crimea: Russia’s economic fears BBC News, Nikolay Petrov (7/3/14)
How Russia’s conflict with Ukraine threatens vital European trade links The Telegraph, Szu Ping Chan (8/3/14)
Will a Russian invasion of Ukraine push the west into an economic war? Channel 4 News, Paul Mason (2/3/14)
Who loses from punishing Russia? BBC News, Robert Peston (4/3/14)
Should Crimea be leased to Russia? BBC News, Robert Peston (7/3/14)
The Ukraine Economic Crisis Counter Punch, Jack Rasmus (7-9/3/14)
UK price rise exposes failure to prepare for food and fuel shocks The Guardian, Phillip Inman (2/3/14)

Questions

  1. What sanctions could the West realistically impose on Russia?
  2. How would sanctions against Russia affect (a) the Russian economy and (b) the economies of those applying the sanctions?
  3. Which industries would be most affected by sanctions against Russia?
  4. Is Russia likely to bow to economic pressure from the West?
  5. Should Crimea be leased to Russia?
  6. Is the behaviour of stock markets a good indication of people’s expectations about the real economy?
  7. Identify some other economic shocks (positive and negative) and their impact.
  8. Could the financial crisis of 2007/8 be described as an economic shock? Explain.