|Last Updated: Sep 12th, 2022 - 01:14:14
It is indeed strange how all of a sudden oil prices can seemingly be contained. Since 1979 we have been led to believe that the price of oil is determined by the market forces of demand and supply; it was about then that governments found the wiggle room that got them out of setting the price of gasoline.
In 1960 the Organization of Petroleum Exporting Countries (OPEC) replaced the seven transnational oil companies (Seven Sisters) that dominated the global petroleum industry on the supply side. The price of oil on the international market is controlled by restricting output by its members through production quotas and has no bearing on production cost. But governments donít mind the racket as they have a nice tax take from the loot of between 20% (United States) and 40% (Jamaica & Canada) of retail price.
Every now and again the price of oil takes a life of its own, mostly due to war. Like the first oil crisis in 1973 the Russia-Ukraine conflict of February 2022 has again led to that. Western sanctions have been imposed on Russia and in response Russia has curtailed its shipment of oil and natural gas to Europe. It has found and expanded trade with China and India who are securing shipments at discounted prices. Because the price of fuel is significantly higher than before the conflict, Russiaís foreign exchange has ballooned and the Ruble has strengthened. This is counter to what the West expected as they sought to deprive Russia of its ability to fund the war having earlier detained Russiaís foreign exchange reserves.
The next brilliant idea is from the G7 (group of 7 largest advanced economies) for a price cap on Russian oil. Russia has emphatically stated that it will not sell to countries that join in on this just as it did earlier to countries that refused to pay in Rubles when it was locked out of the banking system (SWIFT). This is a sellerís market and OPEC does not seem willing and in any case is unable to quickly increase supply to replace oil from Russia. On the contrary, on September 5th OPEC+ symbolically cut production output. There are reports of consumers in France chopping firewood ahead of winter, Germany turning back to coal and UK energy bills set to rise by 80% in October 2022 (pre-emptively capped by PM Liz Truss). Contrast this to US President Biden calling on Congress and states to suspend the federal gas taxes and state taxes to help consumers. The US does not rely on oil from Russia so it is puzzling that the Europeans that do have followed the US down that rabbit hole.
At the onset of COVID-19 in 2020 most governments around the globe opened the fiscal tap to cushion households from the fallout. The thinking was that the threat of public revolt was greater than any damage that could be caused by loose fiscal policy, and in any case they had time to fix it. Interest rates were at historic lows coming out of the pandemic and as economies started to reopen there were supply chain constraints pushing up prices. Initially, most prominent economists and central banks stated that inflation would be transitory. Bank of Jamaica (BOJ) was one of the first central banks to start raising interest rate (September 2021) and the US Federal Reserve started in March 2022. The increases have been sharp and persistent, causing jitters of recession.
The central banks have deliberately focused on headline inflation instead of core inflation (which excludes food and energy prices) to achieve inflation targets. This is impossible given the Russia-Ukraine conflict and its impact on energy (electricity, gasoline and natural gas) and food (grains and fertilizer).
Inflation in Indonesia was among the world lowest as gasoline prices were fixed for the last 8 years.
In an effort to reduce the threat of civil uprising governments are finding creative ways to subsidize energy whether as one off grants to public passenger vehicle operator (Jamaica $25,000) or the UK Energy Bill Support Scheme of L400 over 6 instalments to every household.
There are even talks of proposing windfall profit taxes on oil and gas companies. After 40 odd years could we end up back where the price of fuel is set by governments?
Sources: Reuters News, Bank of Jamaica, Jamaica Gleaner and CNBC
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