The threat of oil prices breaking the 100-dollar per barrel mark has become true in the New Year. This is extremely bad news for Korea, which imports all of its oil. What kind of impact does the unprecedented oil price increase bring for the Korean economy and what does Korea need to do overcome this crisis? First we talk with Dr. Lee Ji-hoon of the Samsung Economic Research Institute about the recent changes in oil prices.

On January 2nd the price of the West Texas Intermediate to be delivered in February broke the 100-dollar mark at one time at the New York Exchange. The oil price doubled in just three years since it exceeded 50 dollars per barrel for the first time in September 2004. On January 2nd the oil price closed at $99.62, topping the previous record high of $99.29 set on November 22, 2007.

The West Texas Intermediate broke the record highs 18 times in 2007 and finally went past 100 dollars per barrel on January 2, 2008. The price hike was blamed on the rapid increase in demand from fast-growing China and India and the sluggish production by oil producing nations. Additionally, political instability in the Middle East and Africa and the weakening American dollar drove up the oil price past 100 dollars per barrel for the first time in history. This has plunged the Korean economy into a state of emergency.

Given that Korea depends on imported oil for its energy demands, high oil prices deal fatal blows to all aspects of the nation’s economy, including business profitability, consumption, investment, and trade balance. Oil prices push up import prices, increasing the cost for exporters, which in turn eats away at their profitability and investment capability. Soaring import prices also diminishes the actual household purchase power, leading to slowdown in consumption and decline in trade balance. Based on past data, when the price of Dubai oil rises by an annual average of 10%, it is estimated that private consumption and investment increase rate fall by 0.67% and 0.26% respectively, while consumer prices go up by 0.23% and trade balance falls 2 billion dollars into deficit.

The Korean economy is particularly vulnerable to oil price fluctuations. Korea relies completely on imported oil for its energy use, yet the nation’s per capita oil consumption is ranked fifth in the world. As a matter of fact, the Korean economy already started feeling the crunch in November 2007 when the average monthly price of Dubai oil shot up to 87 dollars per barrel. Trade balance eventually fell into the red for the first time in 57 months last December and inflation rose by 3.6% to reach the highest level in three years and two months. Also oil-dependent airline and petrochemical industry were so deeply impacted that they seriously considered immediate price increases. Dr. Lee Ji-hoon of the Samsung Economic Research Institute tells us whether the Korean economy can endure a long duration of high oil prices.

We first need to compare whether the current oil prices are anything like those during the oil crisis of the past. Based on the Dubai oil, which takes up the bulk of Korean oil imports, it was priced at an average of 68 dollars per barrel last year, which is about six times greater than 11 dollars per dollar registered during the first oil shock in 1974 and roughly double the 36-dollar level in the second oil shock in 1980. However, if those prices are extrapolated to the current levels based on the inflation rate and today’s lesser dependence on oil, the actual oil prices are estimated at 85 dollars per barrel in 1974 and over 150 dollars in 1980. Therefore, so long as the Dubai oil does not register an annual average of 85 dollars per barrel for a prolonged time, I don’t think the present oil prices are enough to undermine the growth momentum of Korea’s economy. Nonetheless, Korea will have to bear some setbacks in economic growth as the nation’s economy is quite vulnerable to oil price changes.

The current oil prices are not that high compared to those during the first and second oil crisis. Korea’s economy relies less on oil and has much stronger fundamentals than in the past. However, jacked up oil prices do lead to higher costs, which dulls consumption and export competitiveness. In particular, oil prices this year are expected to soar up to as much as 105 dollars per barrel. How can Korea endure and overcome this prolonged oil crisis?

In order to minimize the devastating effects of soaring oil prices, it is urgent to address the pressure of inflation by lowering oil taxes in the short term. The average gasoline price last year in Korea stood at a little over 1500 won for a liter, which is well over the actual gasoline price of 1136 won per liter during the 1974 oil crisis. More than 60% of the current gasoline prices is taken up by oil tax, so it is urgent to lower the oil tax even temporarily to minimize the burden on household expenses. In addition, other public fees or wages should be adjusted to lessen the inflation pressure. In the long term Korea needs to raise energy efficiency and develop new and renewable energy sources to withstand future hikes in oil prices.

The key to surviving in the era of soaring oil prices lies in strengthening the nation’s resistance against oil price changes. In the short term, Korea has to lower the exorbitant oil tax and in the long term, needs to substantially raise independent energy development rate. To do so, Korea needs to focus on developing environmentally friendly technologies, such as hybrid automobiles, hydrogen fuel cell cars, and bio-fuels, and other alternative energy sources like solar, wind, and tidal powers. We cannot dawdle another second, now that the era of 100-dollar-per-barrel has come upon us.