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The Real Reason High Oil Prices Lead to Instability

By Global Risk Insights | Thu, 15 August 2013 00:09 | 0

Businesses rarely gain from political instability so trying to predict unrest is a critical activity for any entity investing in a volatile corner of the world. One of the factors most often cited as contributing to unrest is high oil prices.

Drawing a link between rising oil prices and political instability is not particularly novel. Indeed, it has been pointed out by countless observers who see anger with rising costs leading to political activism. They note that oil is linked to higher costs across the board. The most direct interaction with oil for many people is at a gas station. But oil prices affect the cost of nearly everything else.

For example, the price of diesel fuel for farming equipment alters food prices. This was a major source of concern in Egypt during the revolution, where food inflation has hit double digits multiple times in the past several years.

But if oil prices are really to blame for instability then Egypt also offers a tricky puzzle. Oil prices peaked at $140 per barrel in 2008, before crashing during the Great Recession. They remained at less than $100 per barrel during the start of the revolution in January 2011.

Crude Oil WTI
Source: http://www.nasdaq.com

Related article: Are Oil Prices too Low?

The fact that the Arab Spring timeline does not match the rise and fall of oil prices might cause some to discard petroleum as a critical factor in the revolutions. However, that would be to miss the real political cost of high oil prices.

High oil prices have a delayed political effect, particularly in countries that heavily subsidize petroleum. If oil prices spike sharply and governments are unwilling to reduce subsidies for fear of political ramifications, it can lead to an increase in national debt and a crowding out of public services as an increasing percent of public resources are diverted to petroleum costs.

Egyptian energy subsidies are estimated at $16.8 billion and the Petroleum Ministry is reported to lose roughly 66 percent on each barrel of oil they produce. In more individual terms, Egyptians spend 18 cents USD per liter for diesel fuel at pump stations, while Americans spend over a dollar.

These subsidies were a critical factor in exploding Egypt’s budget. At the start of the revolution, Egyptian national debt was 73.2 percent of GDP and the budget deficit stood at 8.1 percent of GDP. Given such numbers, it is little wonder the government was unable to make significant gains in healthcare, education or infrastructure.

Related article: Oil Prices and Boiling Frogs – Public Beginning to accept High Prices

Egypt Government Budget
Source: http://www.tradingeconomics.com | Central Bank of Egypt

Oil subsidies were not the only driver of this debt burden, but they were a key contributor. This toxic combination of subsidies, rising petroleum prices, and exploding debt is not unique to Egypt. Pakistan and Venezuela are just two examples of other countries facing a similar situation.

The lesson here for companies seeking to avoid instability is twofold. First, rising oil prices can have an indirect political impact through increasing debt and crowding out other government services. Second, this effect may be delayed and not fully felt until repayments become due in later years.

By. Evan Abrams

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