Crude oil prices to rise: The attack on Saudi Arabia’s oil plants

Crude oil supplies – still a major fuel for the world’s economy despite efforts to diversify away from it – are again in uncertain territory.

For the Philippines, as it is for many countries for the world that are dependent on imported oil, this is an unsettling development. Crude prices – to the extent that they will rise – will create challenges for macroeconomic management. They could disrupt and scale down, well-laid economic plans.

A major disruption for world oil supply. An attack this weekend on the Saudi oil processing facility damaged it badly, causing 5.7 million barrels of daily output effectively taken off the world supply.

According to reports, this is the largest single event disruption of oil supply for the world economy, surpassing the impact of the Iranian revolution of 1979. Saudi Arabia accounts for five percent of the world’s oil refining production capacity, but a larger part of world petroleum reserves.

Several large economies – China, Japan, India, South Korea and Taiwan – all put together require some four million barrels daily. That is relative magnitude of the loss on economic activity.

Luckily, there are strategic security reserves that could be drawn on. Some countries would have to make some of that adjustment, including the major producers who stock up on their security needs.

This disruption of oil supplies will mean more periodic and larger swings in prices of essential industrial raw materials affected by oil.

The attack happened on a weekend when markets were closed. The price of crude spiked with initial highs of 20 percent and then cooled and ended, with the price of Brent crude up 10.4 percent at $66.4 per barrel and that of US oil up 9.8 percent at $60 a barrel.

These are only initial first day price reactions. As the consequences and the response to this event become more known, there could be more volatility. Would there be a military counter-strike? Is there a danger of a regional war escalating? Could such a problem go beyond the region?

Many commentators have called the strike at the Saudi oil facility “game changing.” Hence, the question is, how will the game change?

The raging civil war in Yemen was immediately being blamed. The Houthi partisans who are known to be supported by Iran have claimed responsibility. But US intelligence has laid the blame on Iran. Saudi Arabia’s response is still (as of press time) not fully known. It would surely be with some coordination with the US.

Potential impact on the Philippines. On a number of occasions, this column has referred to the regional wars and conflagration in the Middle East as threatening to the oil supply, and to world peace.

This is an example of the escalation of one of the problems that perennially beset the Middle East. It is part of the continuing drama of history over a whole region of unsettled wars, big and small.

Despite some element of diversification away from oil, much of the current productive technology in use in our world is still based largely on petroleum and other carbon-based fuels. All carbon-based fuels have some price links among themselves. Any increases in the price of crude oil on the market also affects the pricing of other fuels based on carbon.

Supply disruptions could mean difficulties in having continuous supply of the fuel. Even if it is available, when disruptions occur, the price of carbon-based fuels also go up.

Thus the price of imported fuels will rise.

After seeing crude oil price go up by 10 percent in the Monday opening of markets, price movements would see much instability if the geopolitical situation in the affected areas becomes more uncertain or, simply, more explosive.

Such price increase would lead to secondary effects. Services dependent on this fuel – transport, electricity, other utilities -- and processed goods would be affected. In short, this is likely to have an inflationary impact.

There is no telling how much increase in the country’s fuel bill will be. There is no way of knowing how the situation unfolds. How sustained could the volatility be as the regional peace and war issues are sorted out by the protagonists? Is there a danger of larger regional confrontations? Would cooler heads prevail? Would world institutions, like the United Nations, keep the situation under control?

The extent of such an increase could affect the trade balance and further worsen it. Due to the government’s Build Build Build program, the trade balance has been worsening as more imports of investment goods swarm the expenditure program and the import bill. This development certainly adds a definite complication to the management problems the country faces.

Hopefully, these developments do not further weaken the economy’s macro-fundamentals. A weakening could show itself in the weakening of the balance of payments, on the value of the peso, and on the nature of the government response when the hard choices make themselves known.

Further vulnerabilities. What could cause any worsening?

One vulnerability could be the cumulative impact of price increases in energy that might result in much higher prices of crude. The recent improvement of the government’s revenues had been based on the tax on the sale of energy products.

Much higher prices of oil could lead to a backlash on the tax rate – a plea for suspension of the excise taxes on energy. Other similar vulnerability could be the demand for wage and other price adjustments that could bring out a cost spiral in prices.

One other vulnerability is related to the conditions of peace and war in the Middle East. A worse case scenario is the possibility of a wider war that involves the big players . This could affect the livelihood of a lot of Filipinos in the Middle East – those not only in Saudi Arabia, but also those spread around in the Arabian peninsula where many OFWs reside.

That would be a challenge approaching Armaggedon for rescue of OFWs in a warzone.

My email is: [email protected] For archives of previous Crossroads essays, go to: https://www.philstar.com/authors/1336383/gerardo-p-sicat. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/