Oil Prices and the Global Economy – Cause & Impact

Oil prices in the past few weeks have surged to more than $100 a barrel in the backdrop of Russia’s attack on Ukraine. The rising oil prices have yet again shown the world how important it is, as global economies search for cheaper deals to fuel their nation’s growth. India and China are picking up cheap Russian crude. Whereas, Western countries, which are said to be discouraging their oil purchases from Russia, are reportedly using the exceptions and exclusions in the sanctions so that they can continue using the Russian crude – a step signifying how crucial oil is for their economies to be up and running.

For countries already in economic distress, it’s a double whammy. For instance, Sri Lanka, which is on the verge of the brink of bankruptcy, increased diesel and petrol prices by SLR 75 per liter and SLR 50 per liter, respectively, in a single day to offset the rising costs of the fuel.

Other nations too are finding ways to deal with an unprecedented rise in crude oil prices. In the current scenario, the question is – How do oil prices impact the global economy? – becomes all the more relevant.

In a bid to provide our readers with a brief on why the world revolves around oil, why crude plays such a pivotal role, and how its shortage can play havoc; here we have listed a few major reasons: 

Heavy Reliance on Oil

Oil, one of the hottest commodities, accounts for about 3% of the global domestic product (GDT). The dangerous habit of relying on crude is widening the fiscal deficit of most nations importing oil from exporting countries. But nothing much can’t be done, as petroleum products are used in almost everything, from fueling your vehicles to manufacturing chemicals, plastics, and even cosmetics.

A renewed focus on clean energy sources could eventually lessen the demand for oil. But that could take several decades, as even chasing renewable energy goals also requires petrol products. For instance, petrochemical-based materials found their use in the manufacturing of solar panels that convert light energy into electricity. It’s literally impossible to imagine an oil-less future, at least for the moment.

Oil Demand Grows as Economy Grows

A developing economy has its own fair share of energy requirements, most of which are met through oil. The larger the economy grows, the more will be its requirement for crude and other energy sources. The Covid-19 pandemic highlighted the fact pretty well.

Crude oil prices briefly traded below $0 in April 2020, when the Covid-19 pandemic had paused economies globally. Less transport, almost zero manufacturing activities, and halted construction plunged the demand for oil at that time. But since then, oil prices have increased sharply, as countries across the world double down on their efforts to offset the pandemic’s impact with a renewed focus on economic activities. 
Rising Oil Prices Fuel Inflation

A major revision in oil prices leads to a change in the price of several commodities that directly or indirectly require petroleum products to hit the markets. Both wholesale and retail inflation picks up the pace when global oil rates are on the boil. According to experts, a rise of $10/barrel in crude oil prices could potentially lead to an increase in inflation by 10 basis points or 0.1%.

The shipping and transport industry is a case in point. Rising fuel prices will force shipping and transport companies to increase the rates for their services. The rising costs are finally passed to the end consumers, which are left with no option but to buy goods at exorbitant rates.

Maciej Kolaczkowski, Manager Oil and Gas Industry – Energy, Materials, Infrastructure Platform, World Economic Forum Geneva, explains that if oil accounts for 3% of GDP, buying the crude for twice as expensive tomorrow will obviously impact inflation. He further suggests that while oil prices do play a role in inflation, it’s loose monetary policies that lead to untamable inflation in a nation.

For instance, governments could offer subsidies on petrol selling at retail points. In this case, customers won’t notice rising fuel prices while refilling the gas tank, but will eventually end up paying more for other goods and services.

Impact on Oil Importers

Oil importers remain on the losing side in case of rising crude prices. The public exchequer has to pay more for purchasing the same quantities of crude in such times, leading to a rise in the fiscal deficit of importing nations.

Controlling inflation in the country becomes a major challenge for central banks and governments. Back in the 1970s, a sharp rise in crude oil meant that the earth is an expensive place to live in. But since then, the reliance on oil economic output has taken a major u-turn. For instance, in the 1970s, the U.S. economy consumed over a barrel of crude per $1,000 of the GDP. By 2015, the figure had dipped to about 0.4 barrels/ $1,000 of GDP.

Minting Time For Oil Exporters

Rising oil prices mean higher revenue collection for countries exporting crude to the world. It’s pretty simple. A sharp change in oil price means that such countries will receive more money for a similar quantity of crude.

The fiscal surplus of major global oil-exporting nations such as the United Arab Emirates (UAE), Saudi Arabia, and Qatar, among others, increases in times of boiling oil prices.

Oil Prices’ Impact on Cost of Doing Business

Oil prices have a major influence on the input costs of the manufacturing and transportation sectors. All companies in the sectors dependent on petrol and petrol subsidiaries have to bear higher input costs, leading to thinner margins.

In such cases, either the companies pass on the increased input costs to the customers or bear the losses. If the costs are passed on to consumers, it impacts their discretionary income, stimulating the economy.

One such major example is the airline industry. Whenever crude prices rise, carriers either bear higher costs or increase the fares for transporting passengers or goods. In contrast, cheaper oil prices mean more affordable airfares and shipping charges.

Oil Prices’ Impact  On Jobs

Oil prices also have an influence on jobs. In the US alone, more than 127,000 people are employed in the oil and gas extraction industry, which is labour intensive. From petrophysicists to engineers, from drilling crews to truck drivers – a large workforce is engaged in the industry. Plus, there are hotels, restaurants, grocery shops, and more near the extraction fields – an integral part of the overall oil and gas industry,

The numbers are much higher in the Middle East nations and Russia. Indeed, many depend on the oil and gas industry to earn daily bread. And a change in oil prices could impact their livelihoods.

The rising costs of oil are pushing countries to invest more funds and employ more people in the sector to find newer oil sources within their territories, leading to a massive generation of employment.

In contrast, low oil prices could lead to massive firings in the industry, crippling the local economy as well. For instance, in 2020, amid the onset of the Covid-19 pandemic, Saudi Aramco, the world’s leading exporter of oil, had cut hundreds of jobs, as oil prices tumbled to record lows.

Oil Prices’ Impact on Banking Sector

As mentioned earlier, oil is one of the hottest commodities. Banks and investors with deep pockets bet on the rise or the fall of the fuel. Brent crude oil futures are traded on the electronic Intercontinental Exchange (ICE).

Moreover, retail and institutional investors have also bet billions of dollars on companies working in the oil and gas industry. A slight change in crude prices can impact the valuation of such firms, some of which are too big to fail.

Summing up!

Hopefully, by now, you must have understood that oil prices impact the global economy in ways more than one. Depending on the conditions, oil could be a job creator or acts as a catalyst in untoward situations. For exporting countries, it’s mostly a winning situation. In contrast, importing nations are often spending a huge chunk of their wealth on purchasing oil to boost their economies.