Perfect Time for Oil Pricing Reforms

Oil prices across the world have been falling over past year. They have headed towards south by more than 50 percent. This phenomenon has caused a lot of hesitation across the globe. The economic effects have been beneficial for oil importing countries and detrimental for oil exporting countries. The major oil exporters are Middle Eastern countries, Russia, Iran and Norway and major oil consumers are USA, China, Germany, Japan, etc.  As a result, a redistribution of resources (oil products) is taking place between winners (oil consumers) and losers (oil exporters).  As oil prices are falling, losers are losing a lot of revenue, which, in turn, is reflecting in their balance sheet as petroleum exports is their major income source. On the other hand, winners are enjoying monetary benefits as their imports are decreasing and fiscal deficits are becoming manageable. So, the dilemma is to find a panacea such that both winners and losers should be comfortable with the prices. In other words, we should decide whether to try to push prices up to discourage oil consumption or to try to push further down to capitalize monetary gains which will also discourage oil production.

To arrive at a solution to this, oil economics should be understood first. Most of the emerging markets have subsidized oil business to keep oil prices below market levels. A recent study by International Monetary Fund (IMF) estimated that global energy subsidies are running at more than $5 trillion per year. These subsidies are disposed as a way to improve income distribution. But the reality is nearly the opposite. Poor people are not the ones who usually prefer driving and use public transport. Less than 20% of the subsidy payments benefit the bottom 20% percentile amongst the society. Last year, Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates have all reduced or abolished subsidies forever. Oil prices, in these countries, are kept floating according to international market rates. As a result, oil consumption is being curbed owing to net increase in oil prices post subsidy removal. Due to large dependence on fossil fuels, an increase in oil prices would directly impact domestic transportation and industrial production.

There is another solution to the dilemma which would cost environmental externalities and national economic security. If oil prices are kept low, it will be consumed at a faster pace. The net impact on consumption is clearly positive for global growth, but the downward price shift will discourage investment in energy production, which will trim overall economic demand. High oil consumption leaves a country (non oil producing) vulnerable to external fluctuations. A good example is political instability in Middle-East affecting global oil prices. Historically, prices have been escalating in the wake of such crises.

At the same time, higher oil consumption would worsen the problem of traffic congestion, accidents and air pollution. So, leaving aside direct economic effects, environmental and other externalities are affected the most.

In a nutshell, the situation demands a tradeoff between environmental concerns and industrial growth. The solution to this problem is that countries should impose both: lower the prices paid to producers and raise the prices paid by consumers, by cutting subsidies and imposing taxes. This will accomplish two objectives- money saved from subsidies and raised from imposed taxes could be used to fund desirable spending and lowered oil consumption would enable us to combat environmental plights and other external disruptions. At the end of the day, the future of oil pricing totally depends on the policies that both consumers and producers make.

-  Vijay Saraf

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