Oil prices have a huge impact on the global economy. Oil accounts for 3% of global GDP. Higher oil prices will lead to an improvement in the current account position of oil exporters like OPEC countries.
Oil demand fell in 2020 amid the pandemic as the price fell below zero for the first time in history due to a major slowdown in economic activity due to the lockdown.
Oil prices have risen sharply to around $100 a barrel after a strong economic recovery after the lockdown. As the economy grows, the oil demand also increases.
In addition, rising geopolitical tensions between Russia and Ukraine and the Middle East are raising supply concerns. This is contributing to rising inflation and worries about economic recovery.
Oil accounts for about 3% of GDP and is one of the world’s most important commodities. A global movement toward sustainability could eventually reverse the low-price elasticity of oil demand.
But as the energy transition continues apace, it’s important to understand how supply and demand factors impact the price of oil and, therefore, the broader economy.
Major effects of rising oil prices
- The oil demand to manufacture many products and its use in the transportation industry, other factors that can cause oil prices to rise to include geopolitical tensions, tight supplies and growing economic strength.
- Oil demand is inelastic, so a price increase is good news for producers as they will see their income increase.
- Higher oil prices will lead to an improvement in the current account position of oil exporters like OPEC countries.
- Higher oil prices will cause the cost of transportation to rise, hence the price of most goods.
- The rise in inflation due to rising oil prices poses a dilemma for policymakers.
- Geopolitical tensions between Russia and Ukraine and growing instability in the Middle East have added to the jitters in the oil market.
- When it comes to oil as an energy source, depending on where you are, 50-60% of what consumers pay at the pump is tax.
Effects of Russia-Ukraine War on Oil Markets
The war in Ukraine has caused major supply disruptions and pushed prices of many commodities to historic highs.
Most commodity prices are now expected to see a sharp rise in 2022 and remain elevated in the medium term. Brent crude oil prices are expected to average $100 per bbl in 2022, up 40% from 2021.
Non-energy prices are expected to rise by around 20 percent in 2022, with Russia or Ukraine being the key exporters with the largest increases in commodities.
More income for oil producers
The oil demand is volatile, so higher prices are good news for producers as they will see their incomes increase.
However, oil importers will have to face increased costs of oil procurement. Since oil is the largest traded commodity, its effects are significant.
Rising oil prices could also shift economic/political power from oil importers to oil exporters.
Higher oil prices will lead to an improvement in the current account position of oil exporters like OPEC countries. This will lead to a deterioration in the current account position of oil importers (eg Germany, and China).
Oil exporters will see an increase in foreign currency reserves that they can use to buy foreign assets. Arab countries such as Saudi Arabia are major buyers of US securities.
An increase in oil prices causes inflation
Oil accounts for 3% of global GDP. So, if 3% of the total global GDP is twice as expensive, that will impact inflation.
But I don’t think it’s a big driver when it comes to inflation. I think loose monetary policies cause inflation.
In this context, oil prices may not be the biggest factor when it comes to inflation but it is still important. Why? Since oil is in basically everything, it’s not a volume effect, but it affects the price of almost everything.
Rising oil prices will not only be seen at the gas station but will be felt in virtually all the goods and services we use. Because oil is a feedstock, a source of energy used to transport many things.
High oil prices increase the demand for electric vehicles
Higher oil prices improve the economics of electric vehicles (EVs) and other alternatives such as hydrogen and other potential mobility solutions, but do not necessarily directly impact renewable energy.
This is because renewable energy is not a direct replacement for oil. Of course, the assumption is that if you go for an EV, you’ll probably want to use renewable energy and that will increase demand for renewables as well. However, in the real world, it’s not that straightforward.
Increasing economic growth is increasing the demand for oil
Two years ago when COVID-19 started, economic activity and oil demand slowed.
Producers were adjusting production levels, but only so much could be done without destroying reserves or capital. Storage capacity is also limited.
Moreover, there was uncertainty about how severe the economic crisis would be and how long it would last.
These complex factors pushed oil prices to very low levels not seen in decades. There was even a brief period when oil prices fell to minus $40.
Impact of rising oil prices in coming years
Higher oil prices in the 2023s will encourage consumers to consider buying electric cars that don’t need oil. In the 2024s, we have more alternatives to oil than we did in the 1990s and 99s.
Also, in the 2025s, high oil prices may not have the same effect on encouraging investment in the exploration of new oil fields. Energy companies are wary of environmental pressures that make the oil less attractive than it once was.
Governments can impose higher carbon taxes or directly encourage less oil use. Therefore, high oil prices may not cause the investment boom we saw in the 1980s.