Oil Prices and Implications for the Developing World

An Interview with the World Bank’s Uri Dadush

Uri Dadush, Director, Economic Prospects, the World Bank

Over the next year and a half, we expect oil prices to come down—maybe around the $100 a barrel range," explains Uri Dadush, director of economic prospects at the World Bank. In an interview with Norbert Jorek, head of A.T. Kearney’s Global Business Policy Council, Mr. Dadush discusses findings from the World Bank’s Global Development Finance 2008 report, released this week.

Norbert Jorek: Uri, the World Bank’s forecast for oil prices appears surprising, in particular as some pundits are predicting prices beyond $200 a barrel. Do you expect prices to come in well below where they are right now? And, if so, will it happen gradually or quickly?

Uri Dadush: We think that over the next year and a half, we will see somewhat lower oil prices than we are seeing at the moment—maybe around the $100 mark. Prices will likely continue to fall further in 2010. It is extremely difficult to pinpoint timing, but when prices do fall, history suggests they will come down markedly over a short period of time.  

Norbert Jorek: What do you consider to be the main reasons for lower prices?  

Uri Dadush: Three things: The world economy is slowing, production is expected to increase, or at least there is a good chance we will see a short-term increase in production, and global demand is slowing down. Production today has been delayed in part because of capacity constraints in the industry, and the reaction to the much higher prices that we have had over the past three or four years is reflected in the slowdown in global demand.  

Norbert Jorek: There is a lot of discussion about the spike in oil prices being due to supply and demand. But some people blame oil speculation. To what conclusion does your analysis arrive?  

Uri Dadush: It is pretty clear that the oil price climb is a case of stagnant supply and surprises on the supply side—meaning a sharper reduction in North Sea oil production, for example. In the first quarter of this year, Russian production fell for the first time in a long while. These surprises, above all, lie at the heart of the problem. In the course of 2007, OPEC was trying to stabilize rapidly rising inventories, and therefore reduce or moderate production. This also contributed to concerns about the supply side.  

Norbert Jorek: Why does OPEC continue to say there is plenty of oil supply?  

Uri Dadush: There is plenty of supply in the sense that there is supply in the ground, of course. There are enormous reserves of oil and generally energy in the world that need to be exploited, and will be exploited over time. But the underlying supply situation in the course of the last year has not been satisfactory. Now, it is entirely possible that speculations in futures markets, covering of short positions, for example, have played a factor. Generally, the reaction of financial markets will be more supportive of the trend rather than going against it, since the financial markets will lose money if they bet against the overall trend.  

Norbert Jorek: How are record-high oil prices affecting the global economy? For example, developing countries have shown considerable resilience so far. Can these countries depend on their growth rates to absorb the higher costs?  

Uri Dadush: Developing countries have generally achieved strong growth rates even as oil prices continued to rise over the past several years. However, their economic positions have weakened over time, and many countries are becoming more vulnerable to external price shocks. In May, prices approached $130 per barrel, nearly double a year earlier. In the context of a slower world economy, the recent hikes may affect growth and domestic demand more strongly than currently projected. Higher oil prices also directly contribute to cost-push inflation of all energy products and also of food. These inflationary pressures have become severe across large parts of the developing world.  

Norbert Jorek: What can these countries do to address the high costs?   

Uri Dadush: This is tough because many countries have seen deteriorating current account and fiscal deficits and for some large energy (and food) subsidies are simply unsustainable. In the short term, the concern is to alleviate the harsh burden that rising prices impose on the poor. Countries in East Asia and Latin America, for example, have faced these problems before and adopted a variety of solutions to fit different circumstances, ranging from targeted subsidies to conditional cash transfers. But sooner or later programs that subsidize energy and food directly need to be reconsidered because they encourage waste of precious resources and they can represent an unsustainable fiscal burden. The decision of when to act has to reflect the country’s specific circumstances and, in the end, is a political decision.  

Norbert Jorek: We have heard a lot of talk about the increased demand for biofuels and its link to reduced food supplies. Is there a new and stronger correlation between oil and agricultural markets?  

Uri Dadush: Historically, oil prices have influenced agricultural prices. Grain production, especially in the United States, is energy- and fertilizer-intensive. This link to fertilizer prices was clearly at work in 2007, for example. But in recent years the link has become much more powerful because subsidies, tariffs and mandates in support of biofuels in the United States and Europe have, together with high oil prices, made the production of biofuels highly (and artificially) profitable, and large areas have been redeployed to produce maize and oilseeds not for food but for biofuels. This means that today's higher oil prices will be reflected in less land devoted to food production. The impact is especially evident on those who live in dire poverty and do not benefit from high agricultural prices. The poor are especially hard hit because they often spend more than half of their incomes on food and energy. Their incomes do not rise in step with these prices, and they have no accumulated wealth to absorb upturns in costs.    

The Global Development Finance report is the World Bank’s annual review of recent market trends and financial prospects for developing countries. With analysis and data extending from short-term bank lending to long-term bond issuance, Global Development Finance 2008 covers issues of fundamental importance to the financing of the developing world. The report can be downloaded at: http://go.worldbank.org/PP2AKPICJ0

The Global Business Policy Council is a strategic service that assists chief executives in monitoring and capitalizing on macroeconomic, geopolitical, socio-demographic and technological change worldwide. Council membership is limited to a select group of corporate leaders and their companies. The Council’s core program includes periodic meetings in strategically important parts of the world, tailored analytical products, regular member briefings, regional events and other services.

Global Business Policy Council
A.T. Kearney, Inc.
8100 Boone Boulevard
Suite 400
Vienna, Virginia 22182
703 891 5500 TELEPHONE
www.atkearney.com