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IMF Sees Oil Prices Staying High

Oil drilling site in southern Sudan. Global oil supply improvements have slowed; IMF expects capacity to build only gradually (photo: Roberto Schmidt/AFP)

WORLD ECONOMIC OUTLOOK ANALYSIS

IMF Sees Oil Prices Staying High

IMF Survey online

April 7, 2011

  • Production constraints limiting increase in supply of oil
  • Growth in emerging markets, particularly China, boosting demand
  • Policies should aim at easing economies’ adjustment to increased oil scarcity

Oil prices are likely to remain high for the foreseeable future and IMF economists say that governments should be looking to back sustainable alternative sources of energy.

According to an analysis by the IMF, released as part of its World Economic Outlook (WEO), global oil markets are in a period of increased scarcity, as oil demand in emerging economies is rapidly catching up with demand in advanced economies and production constraints are beginning to bind in some major oil-exporting economies, where oil fields have reached maturity.

Improvements in oil supply have been slow, reflecting investment bottlenecks and other constraints, and the IMF expects net capacity will build only gradually.

The chapter on oil scarcity assesses the risk for the global economy in the medium term of the supply constraints. A persistent adverse oil supply shock would imply lower global output, higher revenues for oil exporters, a surge in global capital flows, and a widening of current account imbalances.

Oil still dominant

Oil remains the most important source of primary energy in the world, accounting for about 33 percent of the total. The two other fossil fuels, coal and natural gas, account for 28 and 23 percent. The analysis says that renewable sources of energy are in a rapid growth phase, but they still account for only a small fraction of primary energy supplies.

Despite the capacity constraints, the IMF research shows that it is premature to conclude that oil scarcity will inevitably be a strong constraint on global growth.

“Our simulation analysis shows that gradual and moderate increases in oil scarcity, consistent with supply projections by others, may only be a minor constraint on global growth in the medium to long term,” the IMF economists say. In particular, an unexpected sizable downshift in oil supply trend growth of 1 percentage point––from 1.8 percent to 0.8 percent––slows annual global growth by less than percent in the medium and long term.

However, such relatively mild effects on global growth should not be taken for granted since scarcity or its growth effects could be more significant, the WEO analysis shows.

Threats to oil supplies, including geopolitical risks, imply that oil scarcity could be more severe and may materialize in large and abrupt changes. The negative global growth effects would be correspondingly larger.

In addition, it is uncertain whether the world economy can adjust as smoothly to increased scarcity as the researchers assume, given redistribution and sectoral shifts. When oil becomes more scarce, it implies losses to labor and owners of capital in high oil-intensity sectors. Increasing production in low oil-intensity sectors will eventually offset some of these losses, but there could be resistance to change. Another concern is larger negative growth effects because oil scarcity may not just lead to higher costs and lower productivity levels but also hold back productivity growth.

Implications of a supply shock

A persistent adverse oil supply shock would likely result in a widening of current account imbalances, creating greater instability in the global economy. The economists say this underscores the need to reduce the risk associated with growing current account imbalances and large capital flows.

Continued progress in financial sector reform is also critical, as the efficient intermediation of these flows is a prerequisite for financial stability.

Policy response

The research shows two broad areas for policy action to mitigate the impact of oil scarcity.

• Given the potential for unexpected large increases in the scarcity of oil, policymakers should review whether current policy frameworks facilitate the adjustment to such events: macroeconomic policies to ease adjustment in relative prices and resources and structural policies to strengthen the role of price signals would be desirable.

• Consideration should be given to policies aimed at lowering the risk of oil scarcity, including through the development of sustainable alternative sources of energy.


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