Guest Blog: A note on oil price spikes

Adam Dixon

Let’s rewind to early summer 2008. The extent of the financial crisis had not quite reached fever pitch, although the signs of worse things to come were surely there. The global economy hadn’t quite lost steam. If you recall crude prices were still exorbitantly high, and the media was still awash with voices proclaiming crude would breach the $200 per barrel mark in the near future. Well, as you know, they were wrong, very wrong!

Now, to be fair, higher oil prices from a long-term perspective are justifiable for a number of reasons, namely rapidly expanding emerging markets. And yes, all the cheap stuff is quickly running out. You are familiar with the story. And when you see the recent price spike over the last several months, it’s pretty easy to be convinced that markets are entering a ‘new normal’ and that prices will continue their upward march. So will they? Unfortunately, this is really not the forum for that kind of discussion.

What rapid spikes in commodity prices remind us about, however, is the importance of stabilization funds. These funds, which are invested in relatively liquid assets, are a necessary component of budgetary planning for resource-rich countries. They provide governments a reliable source of income when resource revenues disappoint.

However, the scope for long-term (and potentially high risk) investment is, however, all but impossible with stabilization funds. And because commodity prices are volatile, stabilization funds must be relatively large. As a result, this leaves a limited amount of funds left over, at least in the short run, to invest in more compelling and strategic ways — such as in economic development projects, whose risk is actually quite high.

But, this is where the budget comes in, and this is why getting the stabilization fund right is so important. Government budgets are important to economic development, because government budgets are generally the sources of capital that underwrite so much of the necessary infrastructure and human capital investment that supports long-term economic growth. Easier said than done.

Source: US Energy Information Agency

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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