Business World, 11 November 2014


The price of oil has plunged to a new record low. Is this a short-term or long-term phenomenon? Given the demand-supply dynamics, I bet that a rebound in oil prices is unlikely in the short term. With a weak global recovery and strong gas production in the United States, a two-year regime of cheaper oil prices is in the horizon.

On the demand side, efficiency and the switch to alternative fuel have been significant. This was partly prompted by the quadrupling of oil prices from 1998 to 2004. The sharp rise in oil prices has provided incentives for households, firms and governments to change their consumption behavior, enact conservation rules, and invest heavily in oil-saving capital equipment and production processes.

In the United States, efficiency gains and the switch from crude oil to natural gas and biofuels have reduced the consumption of oil products by more than two million barrels per day since 2005, according to the Energy Information Administration.

Most governments would unlikely abandon or reverse existing policy promoting energy conservation. Laws setting vehicle efficiency standards, as well as laws mandating biofuel standards, will continue to be in force. Businesses have embraced energy conserving measures, and these are unlikely to be reversed simply because oil prices have become cheaper.

A weak economic recovery, especially in Europe, a slowing Chinese economy, and a sputtering Japanese economy are dampening demand for petroleum products.

Early this month, Christine Legarde, the head of the International Monetary Fund, warned that the global economy could be faced with a “new mediocre” growth path with high debt and unemployment. She called the recovery disappointing, “one that is brittle, uneven, and beset by risk.”

The US economy is an exception to the overall gloomy economic picture, although its rebound from the 2007-09 Great Recession is its slowest since World War II. Japan’s economic recovery shows weakness after its second-quarter GDP contracted by an annualized 7.1%.

On the supply side, the development of shale gas has emerged as the biggest challenge for oil producing countries. The shale gas has the potential to “change the rules of the game” for the energy industry expanding the field to new players, according to the World Economic Forum’s (WEF) Outlook on the Global Agenda report.

As more players join the shale gas industry, the harder the situation would be for oil-producing countries that “need high oil prices to pay for social stability but that would be threatened if gas is substituted for oil.” These countries include Russia, Iran and Venezuela.

A potential big winner in the shift in energy source is China. The WEF report singled out China with the highest technically recoverable shale gas resources at 1.115 trillion cubic feet.

With the prospect of falling oil prices, what should the government authorities do? Public policy should be dictated by three hard realities. First, lower oil prices means lower revenues from taxes on oil and oil products. For the Philippines, this could mean less government funds to finance the much-needed public infrastructure and investment in human resources.

Second, lower oil prices could possibly change the behavior of households. They might behave as if the economic costs of oil prices are low and change their driving and riding behavior.

Third, at the moment, even when oil prices are high, the economic costs of traffic congestion in Metro Manila are sky high, estimated at about 7% of gross domestic product (GDP). The steady fall in oil prices could change the behavior of the driving and riding public, which in turn could raise the economic costs of traffic congestion into new heights.

Putting all these facts together, policymakers could easily make a case for a temporary surtax on oil and oil products, as long as oil prices remain below $100 per barrel. But once world oil prices revert back to $100 per barrel and higher, the tax should be discontinued. The government should not have windfall gains at the expense of Filipino consumers.

Filipino consumers should not get used to cheap oil since the country is heavily dependent on imported oil.

In addition, lower oil price has the effect of worsening the extremely costly traffic congestion. The government should discourage any change in the economic behavior of households and firms that would increase rather than decrease traffic gridlock.

In sum, I favor an additional tax on oil products for as long as the drop in world price of oil is sustained and is below $100 per barrel. It’s good economics but not necessarily good politics.