Oil Price Rise and Its Macroeconomic Effect Analysis


In the 20th century, the world started integrating on economic grounds. The century saw one of the fastest growths in the history of mankind. Terms like World Economy started making a headline. Most of the nations especially from the western world made full use of this revolution by harnessing their resources with advanced machines and equipment. Transportation got a boost with the advent of railways and airplanes. The world is different than what it was around 100 years back. The main reason behind this economic ride and development has been nothing but using fuels as a source of energy.

The world moved from using wood to coal and finally to oil or better to say petroleum. It is this petroleum over which this industrial revolution bloomed. With very few nations producing oil but being required by the whole world, Oil has been one the most sought-after commodity with oil-producing countries having their coffers flush with dollars. Changes in oil prices have caused a great impact on the performance of the world economy. It has its association with almost every period of recession and inflation (Barrell, 2004, p. 2). Oil shocks of 1974 and 1979 brought an economic slowdown with it. But since 1980, its price remained steady till 2003 when prices started increasing and are currently hovering around $110 -$115 per barrel. The condition is so precarious that it can cause a new oil shock. A 4 percent fall in a global shortfall in daily supply could result in a 177 percent rise in oil prices i.e., the prices will have a dramatic rise from $58 to $177 (National Commission on Energy Policy [NCEP], 2005, p. 2).

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Delving deep into the issue of price rise, some causes came into focus. The list of reasons starts with the restrained production policy of OPEC nations. Organization of Petroleum Exporting Countries or OPEC nations have reversed the upward trend of oil production since 1999 (International Monetary Fund [IMF], 2000, p. 4). Before that rate of increase in oil production was kept at the pace following the rise in demand. But the Asian crisis of 1997 made a further dent in oil prices which got diminished to $11 per barrel. This fall compelled all oil-exporting countries irrespective of being part of OPEC or not to reduce production so that further decline in oil prices is avoided (IMF, 2000, p. 4). This decision started causing effect from late 1999 with oil prices got doubled by the end of the year while the production was forced to fell below consumption causing a deficit. Global reliance on OPEC nations for petroleum is also very important in this scenario. Around two-thirds of global oil reserves are concentrated in Middle East members of OPEC. Relatively new and outside the Middle East resources are small and are very expensive to develop (Organization for Economic Cooperation and Development [OECD], 2004, p.1).

OPEC’s policy of maintaining lower excess capacity often fails to meet the issue of rising supply in the event of unexpected disruption. This low quantity has made the market more volatile and is highly sensitive to short-term supply changes. OPEC has become important that the market pays full attention to it irrespective of the case that it is in the state of action or inaction (IMF, 2000, p. 6). OPEC nations, with the motive to maximize the profit and earn as many dollars as they can, have made a policy of artificially restricting the supply of oil (Hoguet, 2005, p.1). Though OPEC publicly says that it will behave responsibly and will do its best to maintain the oil price at the level which will not hurt the chances of growth of the world economy.

Analysts have predicted that a rise of $10 in the price of petroleum per barrel will reduce the growth of the world economy by 0.3 percent (Hoguet, 2005, p.3). But OPEC’s Long Term Strategy Document shows something else. Instead of giving some certain projection to the volume which they will produce to keep the price of petroleum away from the steep hike, the document adds more to the uncertain nature of the petroleum market (Mitchell, 2006, p. 12). The disappearance of surplus capacity by these nations is adding more to the uncertainty factor raising a big question of their ability to absorb the uncertainties of supply and demand (Mitchell, 2006, p. 12). Way back in 1980, a US Congress Report had stated that the OPEC oil price is the cartel price which is believed to be much higher than the price that should be charged to this oil-thirsty world (Congressional Budget Office [CBO], 1981, p. xix).

With OPEC not in a mood to behave responsibly, other factors are adding more to the problem of price rise. The world is no more a safe place. The menace of terrorism is affecting everyone. It’s no longer a problem for Africa and Asia. People in New York and the people in rich countries like the United Arab Emirates are equally vulnerable. This factor is responsible for the current price rise but also the same in the future. West Asia or the Middle East has got a very bad name because of alleged support to terrorism by some oil-producing nations of the region (US Department of State [UDS], 2006, p.126). The world is so much apprehensive about the possible terrorist attacks that in the year 2001, George L. Perry of Brookings Institution talked about three hypothetical but bad scenarios of oil supply disruption due to the attack of terrorists in the Middle East. In the first scenario, it has been stated that terrorists manage to get control of 8.1 mbd. of Arab oil production. It doesn’t include the supply by Saudi Arabia and its core group of UAE, Kuwait, and Qatar but it includes that produced by Iraq. In the second case, even Saudi and its core OPEC nations think of disrupting the supply because of its extremist leaders and public anger getting alleviated due to the renewal of the Israel – Palestine conflict.

It will shave off another 7 mbd. oil from the market. And finally, the worst case was when the entire Arab oil of 21.7 mbd. comes under the control of extremists. The rise in prices will become steeper and steeper with a possibility of being $161 per barrel in the third condition (Perry, 2001, p. 6). The way terrorists attacked World Trade Centre in the year 2001, the possibility of happening of none of the above stated three conditions can be denied. More troubled the West Asia, the worst is going to happen in the Oil market with a fear of price gaining new heights. The recent attack of Israel over Lebanon has added more to the confusion and it appears that Israel – Palestine conflict will never have any solution. Islamic Republics of west Asia are bound to bow according to their people’s demand of taking a pro-Palestine approach and will do politics of Oil and threat of disruption of supplies. Now the market fluctuates even in case of any rumor or anticipation of another Middle East crisis. Countries in West Asia are not very good neighbors and the Shia- Sunni factor adds more to the already troubled region. The war between Iraq and Iran in the late seventies and early eighties had already sent oil shock waves with an unprecedented rise in oil prices in 1980 (UDS, 2006, p. 132).

The Islamic revolution in Iraq in the year 1979 also played havoc. The alienation of Iran from the western world and its unpredictable behavior over issues like countering terrorism and Nuclear Proliferation is also a fear factor. The more US and its allies will try to punish Iran through the UN, the more it will alienate from the western world and may use oil as a key to show its importance. Leaving out Iran, and looking into the importance of Iraq, the current Iraqi government has failed to contain the situation under control despite the presence of US marines. There is a civil war-like condition and pipelines and oil wells have always been a target of terrorist groups. This has led to regular disruption of supplies from Iraq which contributes around 2.5 million or even 3 million barrels a day (CBSNEWS, 2006). IMF in its paper has also paid much attention to short-term political developments and problems along the production-consumption chain, which receives little attention when the buffer is full but now they are adding more to price uncertainty. They can be like Countries’ request for payment in euros rather than dollars; escalation of conflict between Israel and Palestine and treat all these posses to in disrupting the oil supplies (IMF, 2000, p. 12). Transportation bottlenecks have emerged as new problems. Commercial Truckers may pressurize the governments to cut petroleum taxes causing a spike in the price of gasoline for a short period. The same problem may start with pressure on the tanker fleet as changing geographical consumption of demand (OECD, 2004, p.3).

Moving on to the oil consumption pattern and the changes in fuel consumption due to the rise of new economic giants from Asia, the economic renaissance in the world’s two most populous country namely China and India have opened two new big oil consumers. In the last two decades, China has transformed itself into the world’s factory while India is gaining new heights through its service industry. The two nations have now been the driving force of the world economy along with the United States and are approaching the state of a super-power. Also, these nations have a combined population of around 2.5 billion, and their rising economy has made them major oil consumers because of the rapid industrialization process and growing people’s purchasing power. Looking into the pattern of the change in consumption in these two countries, these developing countries have seen rapid growth with a growth rate being 7-9% in China while India growing at a rate of 5-7% per annum (Economic and Political Weekly, 2005, p. 3).

These countries’ growth in fuel consumption has been so high that total fuel consumption of OCED countries has been reduced to 62 percent in the year 2003 from a high of 73 percent in 1973 (Barrell, 2004, p. 5). These countries have both consumers and producers sucking a large quantity of oil and have made the demand for oil at an all-time high level (BBC, 2006). They are not just big consumers but are also wasting a great amount of fuel. Oil Intensity i.e., primary oil consumed per unit of GDP, is much higher than that of OECD nations. Taking the case of India, it takes two and half times as much oil as developed nations per unit of GDP (International Energy Agency [IEA], 2004, p. 11). In the same way, China and other developing nations of Asia and Africa are equally fueling hungry with very poor use of technology that harnesses oil for energy generation. The use of traditional fuels has now been replaced by modern petroleum fuels for both commercial and industrial processes. So large consumption of fuel by developing countries is making the situation grimmer in the oil market and pushing the prices to reach new heights. With the process of industrialization still in infancy, these countries are paying less attention to technological research and developing better technology for efficient use of this scarce commodity. Low fuel prices in the late 90s and the beginning of the 21st century led them to use less efficient machines and are now the same machines have become major oil guzzlers.


The Oil price is now at around $110-115 per barrel from the figure of $10 per barrel in 2000. Though it is not in a position to touch the figure which was during the period oil shocks of 1979 and 1983 in near future, if this trend continues the figure will one day cross all limits and may affect the world so hard that a very long period of recession will the economy. Energy production through other sources has not been efficient enough to replace oil as the main source. The world is virtually dependent on the OPEC cartel and some other oil-exporting nations for fuelling its growth despite well acknowledging the fact that most of these oil-producing areas are from one of the most troubling parts of the world and always under terrorist threats. These nations are often suspected as major financiers of world terrorism but are equally vulnerable to these elements.

The need of the hour is nothing but minimization of dependence on oil as a source of energy but again in how many years the phases of transfer from fossil fuel to another source like nuclear and wind will take place. And will the world continue to bleed its hard-earned dollars just to quench its thirst for oil? The way Venezuela and Iran are behaving and continuing their anti-west foreign policy, the situation is becoming more uncertain. The price is so much sense that its fluctuation is as fast as the spreading of rumors. The oil was the reason behind the growth in the past and the same can be said about the present. But will it retain its position as the fuel of growth in the future? Will it remain economically viable to fuel growth with petroleum oil or will it act as a necessary evil not only destroying the environment but also impeding the world’s fledgling economic condition of the present? All these questions are quite unanswerable now, but the way oil prices have been changing and the recent attitude of OPEC nations have underlined the fact that Oil will no longer remain the major source of energy.


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Organization for Economic Cooperation and Development (2004). Oil Price Developments: Drivers, Economic Consequences and Policy Responses, France, p. 1, 3.

Hoguet, G (2005). Oil and Controlled Distortions in the World Economy and Their Long – Term Industrial Implications, State Street Corporations, p. 1, and 3.

National Commission on Energy Policy (2005, June 23rd). Oil Shockwaves: Oil Crisis Executive Simulation, p.2.

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