IEEJ: August 2011

Special Bulletin

A Japanese Perspective on the International Energy Landscape (54)August 15, 2011

Fears Growing over Future World Economy and Its Impact on the International EnergySituation

Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, JapanAs fears grew over the future course of the world economy in the first half of August, wesaw plunges, wild fluctuations and destabilization in global stock markets. The Dow Jones Industrial
Average on the New York Stock Exchange posted a steep decline of 1,322 points or 10.9% from12,132 on August 1 to 10,810 on August 8. It went up or down by more than 400 points forconsecutive four days on end, indicating a very unstable market situation. As noted above, the stockmarket plunge was not limited to the United States. Stock prices nose-dived in Europe, Japan andAsia as well, indicating a global stock market decline.

A direct trigger of the global stock market plunge is the U.S. federal debt ceiling problem
taken up in my previous report: “A Japanese Perspective on the International Energy Landscape(53).” Although any breakthrough over the problem had been viewed as difficult, Democrats andRepublicans reached a compromise deal before the August 2 deadline, averting the federal
government’s default, the worst expected development. But U.S. debt rating agency Standard &Poor’s downgraded the rating of U.S. government securities by one notch from the highest level ofTriple A on August 5, claiming the planned budget deficit reduction as insufficient. The downgradeof the rating for U.S. government securities positioned as the most liquid and safe assets in the world
shook confidence towards the U.S. economy and led to growing fears over its future course,
triggering the steep stock market decline.

The latest stock market decline, which mirrors fears over the future world economy, isserious because structural factors exist behind the decline. Factors behind the latest stock market
decline and destabilization are budget crisis and government debt problems, compared with financial
institutions’ debt and nonperforming loan problems behind such developments after the September
2008 Lehman Shock. This may mean that industrial and emerging countries adopted a sharp budget
expansion and monetary easing to fight against a global recession after the Lehman Shock, resulting
in government debt and budget crisis problems, particularly in industrial countries, three years later.
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These problems have become the biggest factor behind the economic destabilization in the UnitedStates and Europe. In this sense, I am concerned that the measures that governments could take inresponse to the current economic fears are limited.

Meanwhile, doubts exist with regard to whether we can expect China and other emerging
countries to play a role in driving the world economy as seen after the Lehman Shock. Although
China swiftly overcame its economic stagnation with its big economic stimulus package, worth 4
trillion yuan, and drove the world economy in the wake of the Lehman Shock, it is now plagued withinflation and asset bubble fears. The Chinese side now fears that quantitative easing III, as rumoredas an economic stimulus in the United States, could add fuel to the inflation and bubble problems inChina. Even the Chinese economy has great challenges regarding its future course.

In the international energy market, crude oil prices have declined in response to thegrowing recession fears. The benchmark West Texas Intermediate crude oil futures price on the New
York market fell by $15.59/barrel or 16.4% from $94.89/barrel on August 1 to $79.30/barrel on
August 9. The North Sea Brent futures price also plunged from $116.81/barrel to $102.79/barrel
during the same period. Later, the WTI and Brent prices recovered in line with stock market
developments. On August 12, the WTI futures rose back to $85.38/barrel. Crude oil prices have thus
kept step with stock markets in the latest destabilization.

Unless financial market turmoil and fears over the future world economy are solved, crude
oil and other energy prices may remain unstable. Downward pressures may be stronger than upward
ones on energy prices. Energy price drops themselves can be expected to have positive effects onenergy consuming or importing countries. If energy price drops are attributable to the destabilizationof the world economy and a recession, however, these drops themselves may have to be viewed as amatter of concern.

We may have to take note of another point. That is the present turmoil’s macro impact oninternational energy supply and demand, particularly a slack energy demand. In 2010, demand for allenergy sources expanded steadily in the world on an economic recovery. In 2009, however, global
demand for all energy sources other than renewable and hydroelectric energy decreased amid a
global recession following the Lehman Shock. This is still fresh in our minds. A sharp demand
decline in the international energy market can lead to dramatic global landscape changes through anglut supply/demand relationship and price drops. It may bring about not only energy supply/demandbalance changes but also great impacts on international relations and the balance of power, including
relations between resource producing and consuming countries, between energy consuming
countries and between resource-rich countries.
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Given structural problems or factors behind the current fears over the future world
economy as described above, I feel that no optimism can be warranted about the future. We may not
be able to deny that great turbulences could emerge in the international energy market from thesecond half of 2011 to 2012.

Contact: report@tky.ieej.or.jp

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