Energy & Power

Special Report
Oil Price Hits $100: What Next?
Should Bangladesh increase oil price in phases or face negative impact?

Farid Ahmed

On 3rd of January 2008, the world and we witnessed a historic event: Oil reached $100 a barrel.

However, if anyone has been reading the articles and commentaries, published by the Energy & Power magazine for the last 3 years, s/he is not only aware that this day would eventually come. Country’s lone energy sector publication has also shown the readers how to prepare their portfolio to profit from rising energy prices. We don’t believe that too few were benefited.

Many economists think the price will stay high and could rise further this year on demand from emerging economies, offsetting concerns that demand could slow in some leading OECD (Organisation for Economic Cooperation and Development) economies.

Demand for oil will and can only rise, driven by the transportation industry because no real alternative is to hand, according to many energy experts.

It is evident that producers of electricity and of energy for industry have moved massively away from oil as a raw material, learning from the oil shocks of 1970s and increasing their use of nuclear power, coal, natural gas and renewable energy. Natural gas is a possible substitute for heating and coal is also a marginal substitute for oil. But in the transportation and chemical sectors, and to a lesser extent heating, demand for oil can only increase by 37 percent overall by 2030, the International Energy Agency estimates. The transportation and chemical industries are growing strongly and substitution in these areas is not easy, comments IEA analyst Lawrence Eagles.

However, OPEC officials lined up to say the exporter group could do little to tame oil prices that hit $100 a barrel for the first time. The comments underline the view of the producer group that factors other than supply are driving oil's record run. "The problem is not shortage of supply," Hojjatollah Ghanimifard, international affairs director at the National Iranian Oil Company, said. Iran is OPEC's second-largest producer after Saudi Arabia. "I think the main problem is outside the oil market. Too much liquidity is available," Ghanimifard said. "A big part of it is in the paper market of crude oil."

OPEC, source of more than a third of the world's oil, decided to keep oil output steady at a December `2007 meeting, rebuffing calls from consumer countries for more supply to rein in prices, then trading around $90.

The Organization of the Petroleum Exporting Countries cannot tame the price rise because it is not a result of supply problems, Qatar's oil minister said. "I don't think OPEC can do anything," Qatar's Abdullah al-Attiyah said. "If this was related to supply then we could move." He said. "Speculation has been very strong. It's a game for speculators."

Impact on Bangladesh Finance & Exports

The rocketing international price of oil will have a negative impact on Bangladesh, hitting government finances through increased subsidies and weakening the buying power of the country's major export markets, according to Bangladeshi experts.

Centre for Policy Dialogue Executive Director Professor Mustafizur Rahman said due to the latest oil price hike in the international market the government subsidy for importing oil will increase significantly, as the government re-fixed the domestic oil price in April last year when the price was $ 55 a barrel in the international market.

Even before the latest price hike it was estimated that the government would have to spend Tk 7568 crore as subsidy on diesel and kerosene in the 12 months from July 2007 to end June 2008, the current fiscal year, according to a report by finance ministry experts.

Mustafizur Rahman said government borrowing from domestic sources will increase, creating more budgetary pressure. “However, it is not the right time to adjust the domestic price of oil in line with the international price, since the government is already reeling under inflationary pressure,” he added.

A senior banker seeking anonymity said the hike in oil prices will not only create a pressure on foreign exchange reserves but also create an extra burden on the government due to the increasing cost of subsidies.

Subsidy: A Solution?

Another expert committee has asked the government to raise the prices of petroleum products as the government will have to spend Tk 7,568 crore as subsidy only for diesel and kerosene in FY08 due to high oil prices on the international market. "The administered prices of petroleum products have generated fiscal and quasi-fiscal costs to the government," the expert report titled 'The macroeconomic impact of rising oil prices on the Bangladesh economy' said.

The report also observed that the administered prices cannot be continued for a long time because of implications for fiscal and current account of balances.

The current prices of petroleum products in domestic market were set on April 2, 2007. The report says that under-pricing of petroleum products poses considerable risk to fiscal management of the government, as the liabilities will have to be shouldered by the government if BPC fails to pay its loan on time. As of November 20, 2007, BPC's (Bangladesh Petroleum Corporation) liabilities to three government-owned commercial banks stand at Tk 3,310 crore with another $585 million debt to Islamic Development Bank.

Referring to the last price increase of petroleum products in domestic market by the government and the prices in international market as of December 26, 2007, the report calculated estimated implicit subsidy for diesel and kerosene for FY 2007-08.

The report says even after the price adjustment in domestic market, BPC's loss per liter diesel and kerosene were Tk 20.49 and Tk 19.67. Estimated implicit subsidy for diesel for the FY 2007-08 would be Tk 6,196 crore, whereas for kerosene, it would be Tk 1,371 crore. In the budget for FY 2007-08, the government has assumed the liabilities of BPC of Tk 7,523 crore and allocated the same amount in the budget as non-cash bond.

The report suggested the government phase out the subsidies in diesel and kerosene within a span of one and half years. "This can be done through periodic adjustments as per the pricing framework of petroleum products approved by the government in November 2003," the report said.

To reduce the adverse impact of price hike of fuel, the report came up with a number of suggestions. The government may select poor households and give them cards to get kerosene allowances to be disbursed by banks and other financial institutions for enabling them to purchase kerosene from the market for lighting purposes, one of them said.

The experts also suggested that the government encourage CNG-conversion of vehicles continuing the duty-free import of CNG-conversion kits and cylinder and equipment for CNG stations.

"As of November 30, 2007, CNG-run vehicles stood at 1,23,573. As a result of this initiative, a total of Tk 3,400 crore was saved from importing oil in FY07," the report said adding, "This has been reflected in the declining growth of import of petroleum products, especially octane and petrol.”

Besides, the report said that to offset the impact of price adjustment on farmers, cash transfers through social safety net programs from the budget may be undertaken for enabling farmers using diesel for irrigation purposes.

Will it Stop? Will it Go Down?

Many analysts expect that prices will decline from the current spike. According to Internet data, if the global economy slows as expected, that will reduce demand for oil. But many analysts warn that given the cold winter in the Northern Hemisphere, prices won't decline substantially until March. If it is correct, that should mean steep declines in the last half of 2008. To get an average of $74 per barrel, current prices will need to fall to about $60. There are some dissenters. The investment firm Goldman Sachs, which correctly predicted $100 a barrel, recently raised its average price estimate for 2008 to $95 a barrel.

Basic economics and politics will determine the direction of prices. On the economic side, many economists are expecting global growth to slow and that would reduce demand for oil. But if the US and European economies continue to chug along, and China and India appear set to post double-digit growth rates again, those could be signals that prices will remain high.

On the political front, events like a war with Iran, a major deterioration in Iraqi security, or even greater instability in Nigeria, could drive up prices if oil traders worry that unrest threatens oil production or shipments.