Oil and the national economy - Shahid Javed Burki

The country’s economy suffers from many structural weaknesses. These have been identified by many analysts over a long period of time but those in policymaking positions have found it difficult to address them.

Without resolving them, the country will not be able to put the economy on the trajectory of high rates of growth on which it can remain without having to deal with disruptions. One of the more serious problems is the inability of the economy to match the increased demand for imports with an equally large – in fact larger – increase in exports. It is only when the rate of increase in exports overtakes the rate of increase in imports by a wide margin that the country will be able to deal with the recurring balance of payments problem.

One reason why imports continue to increase much faster than exports is the economy’s increasing dependence on imported oil. A significant share of the import-export difference is accounted for by oil. This deficit increases when the price of oil in the international market goes up. This happened in most of 2008 with the consequence that the economy plunged into a deep crisis from which it has not yet fully recovered.

But the price of oil plunged as quickly as it had increased. Now, after a pause, it has begun to rise once more. It has almost doubled over the last six months. This has begun to strain the economy once again. Where is the oil price headed and will Pakistan be able to cope with another increase?

There is consensus among experts that while there will be a gradual increase in the price of oil for many years to come, the type of escalation that occurred last year will not happen again. Then the oil markets were caught by surprise because of the unanticipated increase in demand in China and India. This led to a great deal of speculation in the market which pushed up the prices.

Both the markets and the producers are prepared this time. Saudi Arabia, by far the world’s largest producer, has prepared itself well for another run up in prices. It has developed a significant surplus capacity it can use to moderate an increase in oil prices. It is not in the Kingdom’s interest to have the price go much beyond $75 a barrel which is where it seems headed at this time.

Saudi Arabia’s oil reserves are estimated at more than 250 billion barrels about twice as much as Iran’s the second largest holder of reserves. Iran is estimated to be sitting on 130 billion barrels. Iraq with 120 billion barrels has the third largest reserve, followed by Kuwait with 100 billion barrels and UAE with 98 billion.

Venezuela with 80 billion barrels is the largest non-Arab oil country followed by Russia with 55 billion barrels. Khalid al-Falih, the head of Saudi Aramco, the state-owned oil company, expects that demand will grow at a “reasonable pace” by perhaps 1-1.5 million barrels a day from 2010 and beyond.

The Kingdom has recently increased its production capacity to 12.5 million barrels a day following a $100 billion development programme aimed at preparing some of the known reserves for exploitation.

The Saudi officials are much more relaxed now than they were a year ago when there was a great deal of Western pressure – in particular pressure from the United States – to expand supply. They believe that with the implementation of the ambitious development plan they can raise their daily production to 15 million barrels. That would be enough to calm the markets. This is 18 per cent of the global demand of 85 million barrels a day.

The International Energy Agency which advises rich nations on energy matters has also forecast that the type of pressures that were felt by the market in 2008 will not materialise. It is projecting an increase in demand in the next 20 years by a total 25 per cent which would bring global consumption to 106 million barrels a day by 2030.

According to one analysis of the developing situation, “If demand pessimists are correct, future increases in the price of crude could be damped as weaker consumption stretches world oil supply by billions of barrels. Various estimates maintain that the roughly two per cent increase a year average growth rate in world oil consumption seen earlier this decade – the biggest reason for crude prices increases hitting a record $147 a barrel last year – may turn out to an anomaly and that annual growth in the neighbourhood of 0.5 to one per cent is more the norm”.

With that cushion available, the Saudis are beginning to focus on developing their gas reserves for which there is a growing domestic demand. “The big story today is gas”, Mr. Falih told the Financial Times in an interview. The Kingdom is the world’s fourth largest holder of gas reserves but with domestic demand increasing at seven per cent a year, it has no plans to become an exporter, leaving the gas market to countries such as Qatar, Russia and Iran that have large exportable reserves. Mr. Falih says that his company, Aramco, is “exploring kingdom wide” with drilling to begin in 2012 in Red Sea for the first time in order to increase the production of gas.

What do these changes in market conditions and market perceptions mean for Pakistan? A less excited market implies that the country won’t be faced with the kind of crunch it had to deal with in 2008. However, with the price of oil settling at between $70 and 80 a barrel still means a considerable balance of payments burden. There are two options policy makers have to deal with this situation, of which the first can be effective only over the long-run.

A concerted effort should be made to reduce the dependence of the economy on imported oil by developing domestic sources of energy supply. These include not only hydro and coal but also wind and solar. Pakistan, as in so many other things, could take a leaf out of the Indian book. New Delhi has launched a well-funded programme to develop renewable sources of energy, including research in the area.

While it has more financial resources to spend than Pakistan, Islamabad could get the private sector interested in investing in these programmes by offering tax relief. The second is to improve the efficiency of the economy in order to reduce the rate of increase in the consumption of energy.

Among the countries at Pakistan’s level of development, consumption per unit of gross domestic output is high as is the rate of increase in anticipated demand when the economy expands. The recent increases in prices of the products controlled by the government should slow down the rate of increase in energy demand. However, along with the increase in prices the government needs to provide relief to the poor through income transfers.