Columns - The Sunday Times Economic Analysis

Coping with, and responding to high oil prices

By the Economist

Last week we discussed some of the ways in which we Sri Lankans would have to cope with the continuing high prices of oil. There were adequate signs that oil prices would rise though the response of the world at large was slow to put in place policies to cope with the impending crisis. A curious fact is that when the first oil price shock struck the world the responses were far more urgent and compelling than this time. Like many other countries, this time round, Sri Lanka too was slow to put in place policies to reduce fuel consumption. Even now the response is rather inadequate in comparison to the severity of the problem.

One reason for the sluggishness in the reaction was that though the oil price rises were causing a serious dent in the trade balance, other compensating increases in the trade and capital accounts were giving different signals. The trade deficit was not matched by an equally large balance of payments deficit. In fact the country continued to record balance of payments surpluses owing to the higher earnings from tea, rubber, industrial products and large doses of foreign borrowing. However in 2008 the huge increase in costs of oil imports and lesser foreign borrowing and lower capital flows may cause a serious problem in the balance of payments. In fact the situation might be much worse next year and the year after when there would be large repayments to be made. Besides, the high inflationary conditions could hurt our exports.

The first oil price hikes of the 1970s, when there was a fourfold rise in the price of oil, stunned the country and one thought economic activity would come to a standstill. It threatened the balance of payments and several controls were put in place. Like at present, the oil price hike coincided with droughts around the world and food prices rose sharply. Again, as at present the rise in international prices of food coincided with a drought in Sri Lanka and a shortfall in domestic paddy production. It was recognised as a crisis situation and in the controlled state dominated economy of the time rationing and controls were the order of the day. The difficulties people faced then, still linger in the memories of those who went through it, living at that time.

The response to the current crisis has been far too slow and too little, and one feels almost too late not only in Sri Lanka but the world over. The international response to the oil crisis too is interesting and revealing. The first oil shock left a profound mark in many countries. Conserving the use of energy was the tune of the time. For instance, heating was turned down in White House and the US President appeared in a sweater. It was an example for others to emulate by turning off their heating systems and unused electricity. Attempts were made to improve fuel-efficiency of cars. California brought in regulations on fuel efficiency in cars and the Japanese responded with fuel efficient vehicles that captured markets around the world. What a difference between the gas guzzlers of the 1970s and today’s vehicles on US streets and highways! Countries like France embraced nuclear power.

Once again oil prices have quadrupled soaring to nearly $140 a barrel with little prospect of it declining. The reasons for the price increases in oil are several. The stagnant oil output for almost five years and growing emerging-market demand have squeezed the oil market and the slow uptrend has taken a sharp rise in the last two years. Somehow the world has reacted differently. The oil price shock has not still led to drastic actions, only discussions of methods of coping with it. It is not inaccurate to say that the world shrugged it off hoping that prices would abate. In the event expectations were crushed by the Iraqi war and problems in several oil producing countries such as Nigeria and Indonesia. Ironically, Indonesia, despite being an oil producing country, is facing a crisis owing to the oil price increase.

The responses of consumers in many countries have been quite dramatic and sometimes violent. French fishermen clogged up the port of Dunkirk. British lorry-drivers choked roads into London and Cardiff. Many different solutions have been proposed by governments. France's president Nicolas Sarkozy suggested subsidising the worst affected and curbing taxes on petrol. The British government is under pressure to forgo its tax increases on motorists. In the US people have been bitter and resentful of the administration as falling house prices have left consumers who are short of money having to pay more for petrol (or gas as they term it there).Congress and presidential candidates have been drafting schemes and gas-tax holidays like in so many campaign leaflets. Obama may be the gainer in all this in the Presidential campaign. Gordon Brown, Britain's Prime Minister is optimistic and thinks the big oil producers can be persuaded to come to the rescue. However only Saudi Arabia showed any enthusiasm and Brown’s expectations are hardly likely to be realised. World oil output is growing very slowly and consumption in the emerging countries is growing fast. High oil prices are here to stay. Finding and developing new oil fields is an expensive and time-consuming business and cannot keep pace with increasing consumption especially from the emerging countries of Asia.

While the richer countries’ slow and inadequate response may not hurt them that much, in as far as the Sri Lankan economy is concerned, the situation is very different. As a highly indebted country that has to make large repayments of loans, balance of payments deficits in the next two to three years can send the economy reeling. Attempt to reduce oil consumption have to be drastic and yet fashioned in such a manner that the laws of economics are used rather than countered. Talks of petrol rationing send shivers as they are the forebearers of corruption and abuse that does not do much to curb consumption. As we pointed out last week conservation must begin with the government, public agencies and large consumers. Rationing the finances for these to buy petrol would be more effective than rationing petrol. Efforts to generate alternate forms of energy must begin now even though these would take time to deliver. In fact the present crisis is striking us so hard because of not having had a long term strategy to enhance power generation in the past. We need to put in place long-term solutions to take care of future shortages in energy.

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