Rising Oil Prices Don’t Bode Well For Asia – Analysis

By Cyn-Young Park*

Crude oil breached US$130 per barrel in March 2022 — its highest level since 2008 — before retreating to US$100 per barrel in April. The factors behind the rise include protracted low investment in global oil production, a slide in the global inventory and a pick-up in demand related to economic recovery from the COVID-19 pandemic. But most significant was the Russian invasion of Ukraine, which increased supply uncertainty amid already tight market conditions. 

The overall economic impact has been modest in Asia and the Pacific but the situation can change quickly subject to the magnitude and duration of oil price increases. Crude oil prices can overshoot, like many commodity and financial prices. By June 2008, for example, West Texas Intermediate had breached US$140, up from less than US$60 in 2007, only to plunge back to about US$40 by the end of 2008. 

The oil price surpassed US$80 in November 2021, more than double the price of a year earlier, on the back of a strong economic recovery in Asia and the United States. Given the global geopolitical uncertainties and tight supply conditions, another jump is possible. Reaching US$200 is not so farfetched considering that the historic high of US$140 oil in 2008 translates to over US$180 in current dollars. 

Even if US$200 oil does not stick, there is still a risk of higher and more volatile oil prices. For most of the 1990s, oil prices were about US$20. From 2000 until 2007–08, oil prices hovered around US$25–$35. But after the historic high above US$140, oil prices stuck to higher and wider ranges (US$50–100) until 2015. A broader price range is likely in the next five years, should a significantly higher benchmark — be it $180 or $200 — be breached.

Higher oil prices are often economically damaging for net oil importers, as they impact real income and hurt growth. Except for a few oil exporters such as Brunei, Malaysia and Vietnam, most regional economies are net oil importers. Rising inflation is an immediate concern for oil exporters and importers alike, though the fiscal impacts may be less pronounced among oil exporters. For net oil importers, the impacts will also depend on the degree of their oil dependency and how well they cope with adverse balance of payments consequences. 

Past experiences show that countries with large debts and meagre foreign exchange reserves could face harsher adjustments than others. Heavily indebted countries such as Pakistan and Sri Lanka are already reeling from the effects of high oil prices. Their limited access to international capital markets also makes it difficult to finance the immediate gap in their current account balances, causing a sharp contraction in domestic demand. 

Given the rising oil prices and global interest rates, maintaining a stable macroeconomic environment of low inflation and prudent fiscal balances should be a short-term policy priority in Asia. 

Monetary policy is often the first line of defence for necessary short-term adjustments. When the shock is temporary and inflation expectations are low, the monetary authority can afford to care more about growth and employment. But if monetary responses are delayed, inflation expectations could trigger spiral increases in domestic prices and wages. This requires authorities to intervene based on constant vigilance and monitoring against inflationary pressures. 

Keeping modest levels of debt and interest payment burdens is also important in minimising the cost of the necessary economic adjustments to an oil shock. Many countries have incurred significant fiscal expenses during the pandemic through fiscal stimulus packages to ameliorate the adverse economic impact. Despite generally sound macroeconomic conditions in the region, high public and external debts may lead to more abrupt economic adjustments when higher interest rates raise the cost of servicing debts. Countries need to review their debt structures and repayment profiles and take steps to improve fiscal sustainability. 

Longer-term high and volatile oil prices call for measures to promote energy sustainability and efficiency. The oil intensity of an economy may not change overnight but policies that reduce it over time will mitigate the risk of high oil prices in the future. Reducing oil intensity is also crucial for the environment. Developing green infrastructure and fostering green investment could create new growth opportunities. 

Asia’s energy policies need to ensure coherent policy management in a broader policy framework to promote energy transition. Governments in the region must take steps to ensure that energy-intensive sectors move away from fossil fuels towards more sustainable sources. High oil prices should be used as an opportunity to invest in green energy, promote efficiency in energy use and reduce demand for fossil fuels. The only solution to high and volatile oil prices is to phase out the region’s reliance on fossil fuels. 

*About the author: Cyn-Young Park is Director of the Regional Cooperation and Integration Division, Economic Research and Regional Cooperation Department, Asian Development Bank.

Source: This article was published by the East Asia Forum