Policy Study on Impacts of Rising Oil Prices on the Poor and Implications for the MDGs

1
Policy Study on Impacts of Rising Oil Prices on
the Poor and Implications for the MDGs

• Presented to
• UNDP Technical Review Committee
• 23-24 March 2006, Bangkok
• Rekha Krishnan Team
• TERI

2
Study Objectives

• Assess overall economic and social impacts of oil
  price increases on developing countries of the
  region, and their specific impacts on the poors
  access to modern energy services.
• Assess impacts on key economic and social
  sectors, e.g., agriculture, transport, industry
  (especially SMEs), commerce, physical
  infrastructure, health and education.
• Assess impacts on various components of MDGs and
  relate the outcomes to progress made towards
  meeting the MDGs.
• Assess effectiveness of energy strategies,
  policies and mechanisms to enhance the poors
  access to modern energy services against oil
  price increases and continued volatility in
  global markets.
• Identify strategic directions and policy options
  for regional governments to cope with future oil
  price uncertainties, with special reference to
  options to safeguard the interests of the poor.

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Coverage of Interim Reports

• Global assessment
• overall macro-economic impacts at
  international level based on secondary data
• Regional assessment
• region-specific impacts, accounting for
  sub-regional diversities, based on secondary data
• National assessment
• macro level assessment based on secondary
  data, combined with micro level survey of poor
  communities in 2 villages in India

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Key Findings of Global AssessmentHighlights of
recent oil price trends

• Rise in prices, though persistent, has been
  relatively gradual in comparison to some previous
  spikes.
• In real terms, current oil prices are still below
  the all-time highs reached in 1979.
• Recent rise in prices due to a combination of
  strong demand against tight supply and rising
  marginal costs less rather than a consequence of
  supply disruptions as such.
• Oil price rise coincides with a period of dollar
  instability.
• Marked growth in demand for transportation fuels
  gasoline and diesel.

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Key Findings of Global AssessmentAverage
nominal oil prices 1990-2005
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Key Findings of Global AssessmentNominal and
Inflation-Adjusted Monthly Oil Prices 1946-2005
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Key Findings of Global AssessmentMajor factors
underlying oil price increases

• Substantial growth in world oil demand
  concentrated in Asian developing countries,
  particularly China, and the United States.
• Declining excess supply capacity, oil companies
  rationalization and cost-cutting efforts, and
  concentration of excess capacity in a few
  countries leading to increased vulnerability of
  world oil market.
• Unstable Middle-East situation and oil supply
  insecurity elsewhere in Russia, Nigeria and
  Mexican Gulf coast
• Low levels of investment in exploration in Mexico
  and OECD Europe.
• Inflow of speculative money and risk premiums
  emergence which may have caused excessive price
  hikes.
• Underinvestment in the sector, particularly in
  exploration.
• Environmental regulations resulting in reduced
  capacity to manufacture transportation fuels,
  such as gasoline, diesel and jet fuel.

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Key Findings of Global AssessmentPotential
macro-economic impacts based on past experience

• Contraction of economic output 0.25 to 0.50
  per 10/barrel of increase in oil prices.
• Rise in cost of production of goods and services,
  depending on oil intensity of
  sectors/activities.
• Trade deficits due to higher cost of exports.
• Higher general price levels/inflation, with
  possible wage-price spirals as experienced during
  first oil price shocks of 1970s.
• Unemployment triggered by cost-cutting measures
  by manufacturers/service providers.
• Volatility in equity and bond valuations, and in
  currency exchange rates due to changes in
  economic activity, corporate earnings, inflation
  and monetary policy.
• Incentives for energy suppliers to increase
  production (to the extent there is scope for it)
  and investment, including investment in non-oil
  energy options.
• Reduction in oil demand where prices are passed
  through to consumers.

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Key Findings of Global AssessmentActual
macro-economic impacts observed so far

• Decline in world GDP growth by about 0.7 during
  2004-2005, when oil prices rose steeply.
• Stable aggregate consumer price indices for
  developing and developed nations.
• Consistent decline in oil intensity of GDP
  irrespective of oil price trends.
• No marked change in per capita oil consumption.

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Key Findings of Global AssessmentReasons for
lack of dramatic impacts

• Oil price rise coincides with economic revival
  and low inflation where firms and governments are
  less able to pass on higher energy costs to
  prices of goods and services because of strong
  competition and consumer pressures.
• Rapid economic growth in some developing
  countries, notably China and India.
• Weakening of US since 2002, partly offsetting
  impact of higher oil prices in many countries,
  especially in the Euro zone and Japan.
• Relatively low interest rates, though this trend
  is being reversed.
• Question of time-lag, depending on how sustained
  oil price trends will be.

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Key Findings of Global AssessmentOutlook for
future

• Up till 2010, oil markets may remain broadly
  balanced, with incremental oil demand being met
  mostly by higher non-OPEC production.
• However, prospects for higher spare capacity are
  unfavourable, so market will likely remain tight
  and vulnerable to risk of large, unexpected price
  changes.
• From 2010 onward, OPEC supply may increase
  significantly as non-OPEC production peaks while
  global demand continues to rise. However, there
  would be growing upside risks to prices due to
• strong demand side pressures from Asian
  countries, particularly China,
• continued tightness in North American gasoline
  markets
• political instability, especially in the Middle
  East
• long lead times and high costs of establishing
  new refining capacity
• underinvestment in supply infrastructure in
  various countries.

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Key Findings of Regional AssessmentMacroeconomic
impacts of oil price rise

• Real GDP growth Asian sub-regions not adversely
  impacted so far due to economic revival in OECD
  economies which has spurred demand for Asian
  exports. GDP growth flat in Pacific Island
  Countries since 1990.
• Inflation No significant inflationary impact so
  far in South-East Asia, average inflation rates
  in North-East Asia and Mekong, moderate increase
  in South and West Asia since 2000. Relatively
  low inflationary impacts linked to moderate
  pass-through in most economies with administered
  prices for petroleum products. Pacific Island
  Countries with market-determined pricing report
  increases in inflation, particularly
  transportation costs.
• Foreign exchange reserves Increase in all
  sub-regions since 2001, faster than growth in
  current account surplus due to capital inflows
  into the region.
• Trade balance No major adverse impact in Asia
  sub-regions. Significant negative impact in
  Pacific Island Countries.

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Key Findings of Regional AssessmentEconomic
profiles of sub-regions

• North-East Asia and Mekong
• - Relatively health GDP growth rates
• - High inflation in Lao PDR, followed by
  Mongolia and Vietnam
• - Low openness of Cambodia and Lao PDR economies
• - Chinas high foreign exchange reserves
• South-East Asia
• - Negative GDP growth in Timor Lese
• - High inflation in Myanmar
• - Stable GDP growth and control over inflation
  in Malaysia and Thailand
• - High trade deficit of Philippines
• South and West Asia
• - Healthy GDP growth rates in all countries
• - High inflation in Iran and Sri Lanka
• - Indias high foreign exchange reserves
• Pacific Island Countries
• - High dependence on imports
• - Narrow range of exports, dependence on tourism
• - Fiji and Papua New Guinea with greatest
  diversity of economic activities
• - Overall, low dependence on/potential for
  domestic growth

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Key Findings of Regional AssessmentEnergy
profiles of sub-regions

• North-East Asia and Mekong
• All economies, except Vietnam, are oil
  importers. Cambodia and Lao PDR are heavily
  dependent on traditional fuels.
• South-East Asia
• Malaysia is the only net oil exporter, with
  Indonesias status reversed in 2004. Energy use
  patterns differ significantly between nations
  with Myanmar using the least energy per capita
  and largely dependent on traditional fuels.
• South and West Asia
• All economies, except Iran, are net oil
  importers. Afghanistan, Bhutan, Maldives, Nepal
  and Sri Lanka do not produce any oil. Bhutan,
  Nepal and Bangladesh have high dependence on
  traditional fuels.
• Pacific Island Countries
• None of the economies, except Papua New Guinea,
  produce oil. Considerable interest in renewable
  energy sources, though overall shares in energy
  supplies remain low.

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Overall Conclusions of Global and Regional
Assessments

• Eventual impacts of oil price likely to affect
  oil-importing developing countries most severely
• Countries with weak policy frameworks, low
  foreign exchange reserves and limited access to
  international capital markets will be
  worst-affected
• Policy action favouring price pass-through
  (subsidy removal) needed to trigger demand side
  responses
• Technological responses will be crucial e.g.,
  new transport infrastructure, non-conventional
  oil production, renewable energy, efficient
  energy production/use processes/equipment

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Key Findings of National AssessmentIndia
Macroeconomic impacts of oil price rise

• No decline in consumption of crude and petroleum
  products.
• No impact on GDP, including agricultural and
  industrial GDP.
• Only a modes impact on Inflation, partly due to
  partial pass-through of oil price increases to
  consumers and partly due to low weightage given
  to petroleum products in consumer price index.
• Increase in trade deficit.
• No effect on public spending on physical
  infrastructure and social sectors (education,
  health and poverty alleviation).
• Increase in public spending on renewable energy
  development.
• Electricity pricing unlikely to be impacted since
  only 10 of electricity generation is oil-based
  and tariff setting is influenced by several
  economic, social and political concerns.
• Natural gas prices increased 12 for the power
  and fertilizer sectors, and 136 for other
  industrial consumers. No increase in prices for
  small-scale industries and transport sectors.

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Key Findings of National AssessmentIndia
Sectoral impacts of oil price rise

• Petroleum sector Oil marketing companies, which
  bear 85-90 of subsidies on kerosene and LPG, now
  recover one-third of their loss from upstream oil
  companies.
• Transport sector Since 2002, prices of petrol
  increased by 60-70 and of diesel by 80-90, with
  important repercussions for industry due to
  higher costs on account of transportation. Higher
  transportation costs will also impact on peoples
  access to workplace, markets, and education and
  health centres.
• Fertilizer sector Prices unchanged since 2002
  despite growth in international prices. 25
  increase in government subsidy per tonne of urea
  since 2000.

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Key Findings of National AssessmentIndia
Microeconomic and poverty impacts of oil price
rise community-wide impacts

• Income patterns Increase of 25 among poor
  households (income lt or Rs 3,000 per month) and
  by about 61 in non-poor households. No change in
  employment pattern, which continues to depend on
  agriculture.
• Expenditure patterns No change in share of
  energy expenditure in total household spending on
  necessities (including food, energy, water and
  public transport). However, if expenditure on
  diesel is included, energy expenditure has
  declined, possibly due to reduced diesel
  consumption of diesel.
• Impact on major economic activity (agriculture)
  Only 3 out of the 11 farming families surveyed
  owned diesel pump sets, others used electric pump
  sets. All farmers travelled 8-14 kms for various
  activities such as buying seeds, fertilizers,
  etc., and for taking produce to market.
  Expenditure on transportation increased by about
  50. There has also been an increase in
  fertilizer costs of about 25 and pesticide costs
  by over 30.

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Key Findings of National AssessmentIndia
Microeconomic and poverty impacts of oil price
rise direct impacts on households

• Changes in energy expenditure 45 increase among
  poor households and 59 increase among non-poor
  households, mainly due to higher prices of
  kerosene, LPG and diesel.
• Changes in energy consumption 39 of households
  have stopped using LPG/kerosene for cooking while
  44 have reduced consumption of these fuels to
  less than 50. Resultant increase in biomass fuel
  consumption stated to have increased health
  hazards and time expenditure on fuel gathering.
  Many households stay in darkness for longer hours
  due to reduced use of kerosene for lighting.
• Transportation costs Cost per trip by public
  transport to school, health centre and
  marketplace have nearly doubled. Health care
  affected the most due to 8 kms. distance to
  nearest hospital. Some families have withdrawn
  children from better quality schools to lower
  quality schools closer to villages. Poor
  households affected more due to longer travel
  distance and higher reliance on public transport.

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Comments for Follow-Up

• Global Assessment
• Generally benign assessment of impacts so far and
  outlook due to reliance on limited secondary data
  sources need for further research and live
  consultations to present more conservative view
  as an alternative future
• Time lag factor not fully addressed, with
  inadequate coverage of longer term impacts
• Basic assumption of cyclical trend in oil prices
  debatable as there is an emerging school of
  opinion suggesting prices may have entered a
  secular trend
• Importance of US Dollars future and its
  potential adverse impacts on world economy and
  oil prices not fully understood/addressed
• Related to above, potential implications of
  emerging barter trade in oil (e.g., Venezuela)
  and Euro bourse for oil not addressed

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Comments for Follow-Up

• Regional Assessment
• Geophysical and geopolitical informative but not
  very useful to assess vulnerability of
  sub-regions
• Poverty and inequality profiles useful, but need
  to be correlated to energy profiles
• Need for live consultations with different
  stakeholders
• National/micro assessment
• Longer term impacts not adequately covered
• Contradicting results of micro level assessment
  need reconciliation
• Some data, e.g., reversion to biomass due to
  LPG/kerosene price increase, questionable as
  these are not common cooking fuels, especially by
  poor.