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p. 18 of 25 BACK | NEXT Foreword, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia III. The challenge of higher oil prices Adjusting to higher oil prices: The challenge for developing Asia Why are oil prices so high? Why high oil prices matter Policy responses to higher oil prices Long-term responses Conclusions Selected references Statistical appendix

Asian Development Outlook 2005 Update : III. The challenge of higher oil prices

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Adjusting to higher oil prices: The challenge for developing Asia

Oil prices have risen higher--again. Benchmark Brent crude oil prices have averaged $53 per barrel (/bbl) in 2005 through 31 August. Prices climbed toward the $70 level in late August, or nearly three quarters as high again as at the beginning of 2005. No fall in prices seems imminent: oil price futures for end-December 2005 and end-December 2006 delivery are about $67/bbl (Figure 3.1). These developments were not expected. The Asian Development Outlook 2005, released in April this year, assumed an average $41/bbl for 2005 and $39 for 2006.

The region of developing Asia and the Pacific is potentially vulnerable to high oil prices. It is a large net importer of oil (in this section oil is taken to include petroleum energy products excluding natural gas) and much of its rapidly expanding energy needs are met by oil. Developing Asia produces about 11% of the world's crude oil, but consumes more than 20% of it, and this gap is widening. Economies in developing Asia are nearly as oil intensive in energy consumption and much less energy efficient than most industrial countries. For each unit of gross domestic product (GDP), measured at market exchange rates, developing Asia consumes nearly five times as much energy as Japan and nearly three times as much as the United States (US).

Despite its dependency on oil and a threefold increase in nominal oil prices since 2003, the region has performed well economically. But past resilience does not mean that developing Asia is immune to high oil prices. Signs of stress are indeed starting to surface: inflation is creeping up; fuel subsidies are beginning to cast a large shadow over fiscal prospects in some places; and high oil prices may become a prominent factor that will further prolong the region's generally anemic investment demand--outside the People's Republic of China (PRC)--that has prevailed since the Asian crisis.

Sustained high oil prices will require policy responses, and the ingredients of these responses will vary among countries. In many oil-importing economies, fiscal and monetary adjustments will be needed to stabilize impacts on prices and output. Where oil consumption is subsidized, higher prices raise questions about the affordability and objectives of oil price subsidies. For poor countries with limited borrowing capacity, higher import fuel bills could present financing difficulties. But net oil exporters also face challenges. Governments there will need to consider how best to use the additional revenues generated by oil and, if higher prices persist, how to manage pressures for exchange rate appreciation. Over the longer term, governments across developing Asia will need to take decisions about the role of oil in meeting their country's energy needs. Policy choices need to be guided by a framework that promotes greater energy efficiency and environmental sustainability of growth.

This part of the Update reviews the possible consequences and challenges presented by high oil prices for developing Asia. After a brief review of why prices are high, their impact on various economies in developing Asia is examined. Policy responses to structurally higher oil prices are then surveyed, including a brief discussion on the risks inherent in subsidizing oil products. The review ends by setting out key principles for guiding policy decisions, and offering some conclusions.

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