Thu | Oct 17, 2019

Negative oil price shocks add to world economic jitters

Published:Friday | September 20, 2019 | 12:25 AM

Global oil prices jumped from US$60 to more than US$70 a barrel after an attack on an oil refinery in Saudi Arabia on Saturday, September 14.

The world’s benchmark Brent crude oil prices experienced their most dramatic increase in more than 30 years after a negative supply shock depleted approximately five per cent of global supply in the refinery located in Saudi Arabia.

Prices subsequently improved to about US$65 per barrel after United States (US) President Donald Trump announced that he would make US reserves available to be sold to the market. The Saudi government also gave the assurance that normality in oil production would resume shortly in that country. The negative shock to oil supply in Saudi Arabia will have implications for oil importers worldwide and, by extension, the global energy sector.

Since oil prices halved from more than US$100 per barrel to less than US$50 dollars per barrel a few years ago, many of the local retail oil-marketing companies have not fully passed through the benefits to consumers and, as such, have some leverage to play with.

implications for importing countries

The negative supply shock has caused an increase in the price and will have implications for oil-importing countries like Jamaica, which already has a high import bill. How much of this increase will be passed on to consumers depends on the elasticity of demand for both products. Given that oil is a necessity and its prices are controlled by an oligopoly, as well as the fact that marketing companies will not want to undertake the cost, most of the increase will be passed on to consumers.

Jamaica’s import bill is more than four times that of its exports, and the importation of oil is a major contributor to the nation’s trade deficit. Jamaica found itself in this adverse trade position following the first and second oil price shocks of the 1970s. Little has changed since then. Comparing the 1970s to now, what buffers has the country developed to mitigate the impact of these types of shocks in the future? The best way to minimise the effects of these shocks is to diversify the country’s energy sources. Jamaica is exposed to vast amounts of sunlight, wind, and water and can employ any combination of the three to increase the nation’s production of renewable energy. Wigton Windfarm is an excellent start, and more of these initiatives are necessary to move the country forward.

The effects of the negative oil price shock are slowly waning, and oil prices are gradually falling as oil-producing countries assure the world that production will not be affected over the short to medium term. Furthermore, inflation in Jamaica has been very low over the past year, averaging less than four per cent. The Jamaican Government has identified that inflation is below target and, therefore, has been trying to use monetary policy to stimulate economic activity through the lowering of the policy interest rate to 0.5 per cent.

The effectiveness of these policies is dependent on the monetary transmission mechanism that has not been as fluent as we would like it to be. My suggestion would be not to lower interest rate any further until the commercial entities begin to respond more favourably. The Jamaican economy has been negatively affected by external shocks many times, but now, more than ever, the economy is the most robust it has been for decades. However, nothing can be taken for granted, and efforts are required to increase the level of investment and productivity across the island.