Continued strong global demand, supply concerns, and limited spare capacity are likely to keep oil prices high and volatile, according to the latest issue of the IMF’s World Economic Outlook (WEO) and the IMF staff report Oil Market Developments and Issues. The IMFC communiqué also stressed the importance of stable oil prices for global prosperity and called for efforts to remove disincentives to investment in oil production and to promote energy sustainability and efficiency.

Over the past two years, the global economic recovery, high oil demand, and a series of supply disruptions eroded spare production capacity. This pushed up the average oil price used for analytical purposes by IMF staff to about $50 a barrel in March 2005 from an average of about $20 (in 2003 dollars) during the 1990s. “The oil market will remain tight in the coming years, and high and volatile oil prices will continue to present a serious risk to the global economy,” IMF chief economist Raghuram Rajan told the press. High oil prices will be one reason why global growth will slow by 0.7-0.8 percentage points in 2005-06 relative to 2004. The increased cost of oil will be felt particularly in developing and emerging market countries that face external financial constraints.

At what prices will supply meet demand?

According to WEO projections, demand for oil will continue to grow robustly with total oil consumption rising from about 82 million barrels a day (mbd) in 2004 to almost 140 mbd in 2030. Advanced economies are the main consumers of oil but will likely account for only 25 percent of the projected increase in world oil demand in 2003-30. Meanwhile, demand from developing and emerging market countries is seen tripling, driven by expanding use of oil in the business and residential sectors and a sixfold increase in vehicle ownership. “What we see is that around $2,500 per capita GDP, people start buying automobiles,” Rajan said. “Our sense is that the growth in transport demand will come from the developing countries and emerging markets where people finally have the purchasing power to actually buy cars.” With its fast economic growth and large population, China alone will account for almost one-quarter of the increase in world oil demand over the next three decades.

“Part of the reason for the tight oil market is that investment—in exploration, transport, and refining—has been subdued in the past,” Rajan said. And securing adequate oil supplies and spare capacity would be one way of reducing price volatility. However, increases in oil production capacity will likely be slow in the short term, because it takes time to bring new production on stream and restrictive regulatory frameworks prevent investment from taking off quickly. The long term depends mainly on the strategy of the Organization of the Petroleum Exporting Countries (OPEC), which currently produces 40 percent of total world oil output and owns about 70 percent of the extractable reserves. Because of OPEC’s market power and the costs of building new capacity, the WEO suggests that OPEC is unlikely to raise production at a fast pace. Compared with prices over the past two decades, long-term oil prices will be considerably higher—between $39 and $56 per barrel in 2003 dollars.

Preparing for the risks

To reduce the macroeconomic risks arising from oil price volatility, the WEO proposes policy steps in several areas. Greater oil market transparency, especially through better timeliness and quality of data on oil demand, supply, and inventories, would reduce uncertainty and volatility in the market. Obstacles to investments in the oil sector need to be reduced, while efforts to slow the growth of oil consumption should continue. Countries highly dependent on oil imports should maintain adequate emergency stocks to safeguard against potential supply disruptions. Finally, consumers and producers should engage in a more intensive dialogue about expected market developments and policies to reduce the perceived risks of tight oil supplies and help avoid policy actions by importers to curb long-term oil demand.

The IMF staff report Oil Market Developments and Issues also identified general principles that should guide a country’s policy responses, although each country will need to take into account specific circumstances.

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Oil market as a source shocks

periods of low spare capacity tend to be associated with rising and volatile prices.

Citation: IMF Survey 34, 007; 10.5089/9781451938456.023.A007

Data: International Energy Agency; U.S. Department of Energy; and IMF staff calculations.

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