Opinion - George M. Mangion | Wednesday, 08 October 2008
Recession may force oil price to $50
There has been a strong protest from institutions attending the MCESD meeting this month where the proposed new water and electricity tariffs were presented by Minister Gatt. Due to some disarray and prolong disagreements, it is expected that more meetings will ensue so that a happy compromise can be reached to equate the needs and obligations of the industry, hotels, services and last but not least the welfare of employees.
It is obvious that with the impending recession hitting some of central Europe and Britain, it is predicted that our exports and tourist industry may suffer a blow this winter unless alternative markets yielding new avenues of revenue can be sourced. This is not easy as under normal economic terms; firms that can’t raise prices will find profit margins squeezed and will have to cut back on production and jobs. Even if some producers of energy-intensive products can raise prices enough to cover higher energy costs, they’ll nonetheless export fewer of their products because of those higher prices.
So logic will dictate they too will have to cut back on production and jobs. It was anticipated that subsidies on energy prices in Malta needed a drastic revision and this has been the subject of a special study commissioned by Enemalta from a local audit firm. Although I have not seen a copy it was commented that the tariff structure based on such a study made for unpalatable reading with the constituted bodies and the unions. They all fear that now is not the time to risk starting the tribulations of an induced slowdown.
History has shown that domestic inflation due to increased cost of production has always resulted in a drop in demand for products and services. It is not inconceivable that union and employers protestations call for a smoother spread of the cost of oil. Ideally its cost is thinned down to cover a longer period in spite of the infringement notice by the Commission that capping of the surcharge for heavy users must stop being discriminatory.
Yet it has to be said that a more harmonious and equitable formula may still be eluding the government and this may need more time for study and reflections on ways of how to secure the viability of Enemalta. Given the vagaries of oil prices it is retching how party apologists have been conditioning the electorate since last April about how prices may reach the $200 mark. For most of 2008 oil has been well over $100 a barrel, causing pain at balancing the cash flow at Enemalta. Paradoxically one notes how Merrill Lynch analysts predicted that the price of oil could sink to $50 a barrel next year, if the economic slowdown deepens into a global recession. This could be a blessing in disguise because Government may still not be in a position to drop taxes on energy so as to buttress a drop in revenue from other sources due to shortfall in direct and indirect taxes.
Back to oil, in July the price spiked up to $147 and this had sent all projections for future deliveries haywire. All this uncertainty has been the root of previous slowdowns and in extreme cases even a recession. Nine out of 10 previous postwar recessions began shortly after a big spike in the price of oil. Yet those recessions always forced down oil prices dramatically.
True to this trend we notice how US crude oil dropped to $89.38 last week trading, a fall of $4. This reflects concerns that demand for energy will drop as the global economy slows. We know for a fact that Enemalta has hedged its oil supply on the $85 per barrel mark and this is reflected in the capping mechanism and the current surcharge imposed of 95%. A drop in price is welcome news and upon reflection it is the first time since mid-February that oil dropped below $90, and let us hope more cuts will follow as this will concurrently force food prices down.
It is not surprising that oil producers are starting to feel the pinch of a levelling down of prices coupled with lower demand for their monopolistic advantage as suppliers of the so-called liquid gold. But leaving oil aside, immediately one ponders if the credit crunch was all about a few bad apples in Mr Bernanke’s barrel or whether the contagion in US financial markets has had central bankers and politicians across Europe rushing to reassure savers that their deposits will be protected. The woes that have struck European banks and financial institutions prove, if proof is needed, that the malady is global.
Suffice to mention the collapse of Hypo Real Estate, Germany’s second-largest property lender together with Fortis, the Benelux bank saved by BNP Paribas; while Icelandic officials were desperately trying to find the capital needed to rescue its banking sector. Last week Icelandic bank Glitner was nationalised, after bank lending dried up and trading in Icelandic financial institutions was suspended as the Icelandic Crown cascaded by 23%. If this is not enough, three more European countries, namely Germany, Austria, Denmark and Greece lead by guaranteeing all personal savings accounts to thwart fears of a meltdown.
Naturally such moves were not favoured by the Commission stating that they could violate the EU Treaty. So is everyone taking to his own devices? It appears so since the Irish Government forked out a rescue pack of $400 billion to guarantee all domestic accounts, and Sweden followed suit saying that it has doubled its saving guarantee to 500,000 Swedish kroner (£40,000), while Spain warned that it might also announce a protection scheme unless there was coordinated action across Europe. All this points to the fallacy that the credit crunch had its tentacles reaching out only to American banks championed by sub-prime lending.
The round-up of protection measures triggered by various European banks points to signs of acute stress accentuated by a growing sting of recession. Thus we see how the logical drop in the price of oil makes commercial sense considering that global economies are feeling the pinch of higher unemployment, reduced domestic demand and slower GDP growth.
To mention a few examples let us look at France where official statistics reveal quarterly growth rate slowed from 0.7% in the third quarter of last year to 0.4% in each of the next two quarters, then went negative by 0.3% in quarter two of this year. The prediction is that GDP is to contract again in the third quarter. On pure economic terms, this is technically a recession: two consecutive quarters of falling output. Now let us move to the sick man of Europe – Italy. Here GDP fell in both the fourth quarter of 2007 and the second quarter of this year, dragging the already lacklustre growth rate down to zero. Germany’s output fell by 0.5% in the second quarter, pulling its annual growth rate down to 1.7%. Spain, for example, announced a huge 7% annual drop in industrial output last Friday and is seeing a sharp rise in unemployment.
The good omen is that oil prices will start sliding back to the levels of $50 a barrel range sooner rather than later. Once this happens then we can all breath a sigh of relief. After all the bickering at the MCESD, we can see some light at the end of the tunnel. The new tariffs proposed may taste like a poisoned chalice but at present there are no antidotes to mitigate the drink. Should oil really drop to below $50 a barrel then Dr Gatt can safely save the unbearable burden on the national budget which at the moment chips off an amount is equivalent to 1.2 per cent of GDP.
A global slowdown which forces down energy prices is no panacea but at least as an oil dependent country we can start devising ways on how to mitigate the pangs of an looming recession.
George Mangion
Partner at PKF – an audit and business advisory firm [email protected]
