Capitalising on fall of black gold

With oil prices in international markets tumbling to the bottom, a lot of commentary has pointed out that this is a “shot in the arm” for the global economy. According to Olivier Blanchard, chief economist at the IMF, world economy stands to gain by 0.3% to 0.7% in 2015 compared to a scenario without the drop in oil prices. The reasons behind the fall are widely known. Europe's prolonged crisis coupled with China's recent slowdown has sapped demand; the Shale-oil boom, along with rising production in Libya, has created the glut. The major beneficiaries from the fall in prices are net oil importers such as the United States, China, Japan, India etc.

Similar to these countries, Bangladesh stands to gain since we import around 5.7 million tons of oil annually -- comprising the largest share of 11% in our import basket. Yet, domestic prices have not been adjusted to international markets. The primary factor has been attributed to Bangladesh Petroleum Corporation's (BPC) cash crisis and obligation to meet targets set by the National Board of Revenue (NBR). However, the benefits from maintaining current price for the sake of BPC is not greater than the multifaceted gains Bangladesh can get by adjusting prices to global markets.

Before reforms aimed at capitalising on the decline in oil price can be considered, policy-makers need to identify whether the crash is transient or if we will see a lower and new “normal” in oil prices for some time. Recently, the International Energy Agency (IAEA) stated that demand for oil in 2015 will be significantly less than previous forecasts as global economies remain weak, and that prices may continue to slide unless Opec counters the supply surge. Another school of thought hypothesises that prices might bottom-out soon but will be significantly lower than the lofty $100-plus levels seen before. Furthermore, with rising geopolitical tensions between Opec and non-Opec oil producers, the consensus is that prices might settle between $60-$80 a barrel. Whichever of these predictions comes to being, it seems clear that lower prices is the new norm for 2015.

Our government can benefit from this “new norm” by completely eliminating fuel subsidy for this and the next budget. Subsidies, by design, are double-edged swords. The main benefits end up going mostly to the richest citizens and crowd out more productive government spending and reduce energy efficiency. The funds saved should be reallocated to more fruitful development expenditures like infrastructure, health and education. One major argument against price adjustment is BPC's obligation to meet targets set by NBR. With the opportunity of removing distortionary subsidies at hand, the government needs to collaborate with NBR on reducing revenue targets to ease BPC's obligations.

Another concern with price adjustment is BPC's massive cumulative loss. By selling at old prices, BPC can return to profit after 13 years. But this is a highly suboptimal arrangement for the economy as a whole. Lower oil price is a significant opportunity to improve profitability of the entire manufacturing sector -- and suddenly BPC's interest has shifted to generating its own profitability!

As many local experts have pointed out, the general population should not be the scapegoat and BPC's financial crisis should be addressed through longer-term plans with energy-sector specialists and business veterans to guide the enterprise at the management level. Moreover, if profitability of the manufacturing sector improves, the government stands to gain from higher corporate tax collection, which should offset, at least partially, the loss of revenue from reducing BPC's obligations to NBR.

Another argument standing in the way of price adjustment is inadequate storage facilities. One strategy can be to allow the private sector to import oil. Recently, the government has allowed some fuel oil-run private companies to feed their own factories and power plants. This practice should be encouraged and the government should allow more private sector companies to import oil -- but only after careful screening of company fundamentals and management efficiency and integrity. This policy, apart from increasing storage capacity, would also bring quality service in the energy sector and create benefits at the retail level. 

On a slightly different note, by lowering prices, the government gives the manufacturing sector some cushion to fully implement higher minimum wage for labour. Reports as recent as December 2014 state that nearly 20% of RMG factories have not implemented the minimum wage structure even a year after the pay hike was made official. Another 40% has done so only partially. Lower oil prices would significantly reduce overhead and operating expenses and allow manufacturing units to reallocate some of these savings to salaries and wages.

Finally, letting international prices feed into the retail level will lower inflation. This translates into higher disposable income and potential for greater investments. For Bangladesh, it can also hedge against rising inflationary expectations due to the recommended pay hike of civil servants from the next fiscal year.

The gains from reducing domestic oil prices far outweigh the benefits of maintaining higher prices. We may be looking at greater manufacturing sector profitability, more fiscal efficiency and higher disposable income. This is not just about greater real GDP growth, but also higher inclusive growth. Adjusting prices is, therefore, a logical and promising decision which the government should not delay much longer. 

The writer is a graduate student in International Economics at Johns Hopkins University in Washington D.C.

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