The impact of rising oil prices

The rising cost of energy is an issue that is currently at the top of the agenda of governments and industry across the globe. That is because a barrel of oil now costs more than twice as much in dollar terms as it did in 2001. In relative terms however, oil was much more expensive in the 1970’s and 1980’s. Indeed the $8.50 rise in the price of a barrel of oil between August 1973 and January 1974, while small in dollar terms by today’s standards, nevertheless amounted to a 274% jump in the cost of crude.

Rising oil prices lead to higher business costs, thereby reducing profitability. Many businesses such as airlines will seek to pass this on to the consumer, cutting into household income in the process. British Airways for example, has raised its fuel surcharges for a second time and are charging an extra £48 on each long haul return ticket. {{more}}Not all companies will be able to do this, but lower profitability could encourage them to lower their costs in other ways – perhaps even by way of reducing staff. Such a scenario can become like a chicken and egg situation: Lower profits lead to job losses and consequently to lower consumer demand, just as higher prices, both at the fuel pump and on supermarket shelves do the same. And ultimately lower consumer demand hurts company profitability.

Alcoa, the world’s largest aluminium company has come up with a new strategy to mitigate the effects of higher costs. The company is building new smelters in parts of the world where energy costs less. Profitability depends on what you make of the opportunities that are still out there. Alcoa has plans for new smelters in a range of countries including Iceland, Trinidad and Tobago and China. The Iceland project is due to commence production in April 2007 and will benefit from the country’s abundance of geo thermal energy (using the heat generated by the earth’s interior). In Trinidad, Alcoa is looking to build a similar sized smelter (344,000 tons per year), using the island’s plentiful supply of gas as an energy source. The smelter will have its own power station to be built in a joint venture with the government of Trinidad and Tobago. Smelters consume large amounts of electricity and power is the biggest cost in the production process. The emergence of carbon fibre composites as a strong and lightweight alternative to aluminium means that the latter’s dominance in the aerospace industry is under challenge as never before. Boeing has decided that half of its new 787 dream liner passenger jets due for service in 2008 would be built from composite materials. The use of composites alongside the new advanced engines will make the aircraft more fuel efficient and cheaper to run than older jets. The share of aluminium on Boeing’s aircraft will fall from 70% on the existing 777 to just over 20% on the new 787.

International oil prices have risen by over 50% in the past year and this recent occurrence seems to suggest elements of a permanent shift in prices which must eventually impact on our domestic price structure. In many developing countries, the OECS included, a subsidy component has been incorporated into the price structure for fuel with a view to bringing about greater equity among consumers. The reality however is that this is not sustainable over the long run.

The Petro Caribe agreement with Venezuela is one response mechanism which may offer some relief to St. Vincent and the Grenadines. Some of the main features are as follows:

1. There is a sliding price mechanism that is linked to international oil price thresholds, so that at a price of $50 per barrel of oil, participating oil importing countries will settle 60% of the price upon receipt of the commodity. The remaining 40% is being financed through a loan from Venezuela.

2. The loan is extended for a period of 25 years to maturity, with a 2-year grace period at 1% rate of interest.

3. A portion of the loan can be repaid with commodities or services in a counter trade or barter transaction.

The Petro Caribe agreement will therefore have the effect of transferring purchasing power from Venezuela to participating oil importing countries like St. Vincent and the Grenadines. It could also be construed as extending development aid when the highly concessional rate of interest is taken into account.

Is the Petro Caribe Agreement a sufficient response by St. Vincent and the Grenadines to these periodic oil crises? Will the next visitation of an oil crisis find us equally dependent on this fuel as a source of energy? Business Corporations have tended to take a proactive approach and conduct research, which can lead to a more efficient use of their raw material input. The world’s largest aluminium company and one of the leading aircraft companies are examples of business entities that are constantly looking at their bottom line. Trinidad and Tobago is leveraging its abundant supply of natural gas as a cheaper source of energy and in the process attracting investors to enter into joint venture operations. Brazil has been utilizing the waste material from sugar cane to produce an alternative fuel. Many laypersons hold to the view that waste material from the banana plant may similarly be used to produce ethanol. Our local researchers in collaboration with others in the field could set to work on a project that may point us in a direction that allows us to become less dependent on oil, well before the next crisis arrives.