India: 'outrageous' oil price damages economy, as $80pb could be new floor price

High oil prices have negative impacts on a range of social and economic activities, especially in the developing world. The least developed countries are energy intensive and consequently spend much more on oil as a percentage of GDP than highly developed countries. According to the African Union, Sub-Saharan African countries poured between 10 and 15% of their GDP into oil imports in 2006, whereas OECD countries spent only 1.5-3%. In oil importing poor countries, each price increase can be felt immediately throughout the economy on both the macro- and micro-economic front, with poor classes suffering most (earlier post).

Palaniappan Chidambaram, Finance Minister of India, which is heavily dependent on oil imports, illustrated some of the effects today by calling the current price for crude oil 'outrageous' and damaging the economy's growth.

The price of crude oil is an enormous external risk. Since these outrageous prices cannot be fully passed through to the consumers in India, the burden falls largely on the domestic budget and constrains our capacity for investment. - Indian Finance Minister Palaniappan Chidambaram

India imports nearly three-fourth of its crude oil requirement and spent more than $57 billion in 2006-07 for the purpose - almost equal to the country's entire trade deficit. Government has not allowed state-run oil marketing firms to raise fuel prices in line with cost and India's three main oil companies are projected to suffer a revenue loss of about 13 billion dollars this year.

Chidambaram also warned the depreciation of the dollar vis-a-vis the rupee has thrown up an unexpected downside risk. The Indian currency has strengthened more than 11 per cent in 2007, hurting exporters.

Forecasts: record price guaranteed
Meanwhile, the oil industry says the price is justified because the money is needed to invest in new exploration and refining capacity (earlier post). Recently, Iranian government spokesman Gholamhossein Elham even went so far as to state:

We, the oil exporting countries, believe the oil price is low and is not the real value of this important material of the world’s energy [mix].

Reuters published a poll on Wednesday asking petroleum (establishment) analysts to predict the average price for US crude oil in 2008. The result: $67 per barrel. However, Goldman Sachs, the most bullish in the poll, predicted WTI crude to average $85 next year with prices climbing as high as $95 by the end of 2008.

Peak Oil analysts are being taken more and more seriously, because they have been more accurate in their predictions. So what do they say? The Association for Peak Oil & Gas (ASPO) concluded at its latest annual conference that the new floor price of crude oil is $80 per barrel. The projection was shared by Ray Leonard, Vice-President of Kuwait Energy Company, James Buckee, CEO Talisman Energy, Jeff Rubin, chief economist of the Canadian Imperial Bank of Commerce and James Schlesinger, former U.S. energy secretary. Today, the ASPO's 1 year forecast stands at $107 pb.

Obviously, a price bracket of $67 to $80 makes biofuels a must for developing countries. Many first-generation fuels can be made at costs well below these prices, and we see a continued push into 'tropical' and 'subtropical' biofuels next year dominated by ethanol made from sugarcane (average production cost in Brazil: $37 per barrel of oil equivalent), sweet sorghum and cassava (projected production cost in Thailand: $38pboe), and by biodiesel made from palm oil (projected cost in Malaysia: $55pboe), jatropha and soy oil. But at $80-100, some second-generation biofuels too become competitive with crude. Amongst these, fast-pyrolysis based fuels and synthetic biofuels based on the Fischer-Tropsch process would be commercially viable (earlier post). Cellulosic ethanol based on enzymatic hydrolysis would require higher prices still. With the current state of technology, algae-based biofuels would need an oil price bracket of $120-150 to be competitive.

Catastrophy for poor countries
In energy intensive countries, the macro-economic effects of high oil can include higher inflation (including increased food prices), less economic growth, higher unemployment, and a weakened capacity to ease the debt burden:
energy :: sustainability ::biomass :: bioenergy :: biofuels :: crude oil :: peak oil :: energy intensity :: developing countries :: India

Such countries do not have the technical and financial instruments to deal with oil shocks, such as reserves and finetuned monetary policies. Most importantly, governments are often forced to cut spending on social services, with the UN finding that some of the poorest countries are already spending twice as much on importing oil than on such basics as health care. Of course, the poor suffer under all these factors most.

On the micro-economic front the consequences depend on government policies. In countries where fuels are not subsidized, the effects for the poor can be truly catastrophic: higher costs for food, for heating and cooking, and less mobility. Energy can take up to 30% of the household budget of families in the least developed countries. Farmers have a reduced capacity to bring their produce to market - a major problem in the Global South, where the majority of people live in rural areas and is employed in agriculture.

When petroleum fuels are subsidised, as is the case in India, the costs are transferred to the government, which then has a reduced capacity to invest in state and social services (education, health, security, etc...). Ultimately, the costs arrive at the population at large.

A more extensive overview of the effects of high oil prices on the least developed countries can be found here.


References:
The Economic Times: FM warns against crude oil prices hurting GDP growth - September 27, 2007.

Reuters: Oil prices seen surging to record level next year - September 26, 2007.

Peakoil Netherlands: Iran: oil at $80 per barrel is cheap - September 24, 2007.

Biopact: High oil prices disastrous for developing countries - September 12, 2007

Biopact: Report: synthetic biofuels (BtL) and bioenergy efficient, competitive and sustainable in Germany - September 22, 2007