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, BangkokRekha Krishnan & Team

TERI

Study Objectives Assess overall economic and social impacts of oil price increases

on developing countries of the region, and their specific impacts on the poor’s 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 poor’s 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.

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

Key Findings of Global Assessment:Highlights 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.

Key Findings of Global Assessment:Average nominal oil prices: 1990-2005

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Average of NominalPrices of Brent, WTI andOPEC Basket ($ perbarrel)

Key Findings of Global Assessment:Nominal and Inflation-Adjusted Monthly Oil Prices: 1946-2005

Source: Financial Trend Forecaster, 2006

Key Findings of Global Assessment:Major 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 premium’s 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.

Key Findings of Global Assessment:Potential 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.

Key Findings of Global Assessment:Actual 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.

Key Findings of Global Assessment:Reasons 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.

Key Findings of Global Assessment:Outlook 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:

o strong demand side pressures from Asian countries, particularly China,

o continued tightness in North American gasoline marketso political instability, especially in the Middle Easto long lead times and high costs of establishing new refining

capacityo underinvestment in supply infrastructure in various

countries.

Key Findings of Regional Assessment:Macroeconomic 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.

Key Findings of Regional Assessment:Economic 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- China’s 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- India’s 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

Key Findings of Regional Assessment:Energy profiles of sub-regions

North-East Asia and MekongAll economies, except Vietnam, are oil importers. Cambodia and Lao PDR are heavily dependent on traditional fuels.

South-East AsiaMalaysia is the only net oil exporter, with Indonesia’s 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 AsiaAll 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 CountriesNone of the economies, except Papua New Guinea, produce oil. Considerable interest in renewable energy sources, though overall shares in energy supplies remain low.

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

Key Findings of National Assessment:India: 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.

Key Findings of National Assessment:India: 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 people’s 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.

Key Findings of National Assessment:India: Microeconomic and poverty impacts of oil price rise — community-wide impacts

Income patterns: Increase of 25% among poor households (income < 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%.

Key Findings of National Assessment:India: 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.

Comments for Follow-Up Global Assessment

o 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

o Time lag factor not fully addressed, with inadequate coverage of longer term impacts

o 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

o Importance of US Dollar’s future and its potential adverse impacts on world economy and oil prices not fully understood/addressed

o Related to above, potential implications of emerging barter trade in oil (e.g., Venezuela) and Euro bourse for oil not addressed

Comments for Follow-Up

Regional Assessmento Geophysical and geopolitical informative but not very

useful to assess vulnerability of sub-regionso Poverty and inequality profiles useful, but need to be

correlated to energy profileso Need for live consultations with different stakeholders

National/micro assessmento Longer term impacts not adequately coveredo Contradicting results of micro level assessment need

reconciliationo Some data, e.g., reversion to biomass due to

LPG/kerosene price increase, questionable as these are not common cooking fuels, especially by poor.