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compensate fully for lower production. Higher oil prices in the last four years are in part the result of OPEC’s success in implementing its policy of collectively constraining production. This policy has led to a decline in OPEC’s share of world oil production from 40% in 1999 to 38% in 2003.

There is a risk that this policy may be continued in the future, which would limit the extent to which OPEC producers, notably those in the Middle East, contribute to meeting rising world oil demand. According to the IEA’s latest World Energy Outlook, OPEC’s market share is projected to rebound to 40% in 2010 and 54% in 2030.

In the IEA’s recent World Energy Investment Outlook, cumulative OPEC revenues are $400 billion lower over the period 2001-2030 under a Restricted Middle East Investment Scenario, in which policies to limit the growth in production in that region lead to on average 20% higher prices, compared to the Reference Scenario.

Impact on the Global Economy

The results of the sustained higher oil price simulation for both the OECD and non- OECD countries suggest that, as has always been the case in the past, the net effect on the global economy would be negative. That is, the economic stimulus provided by higher oil and gas export earnings in OPEC and other exporting countries would be outweighed by the depressive effect of higher prices on economic activity in the importing countries, at least in the first year or two following the price rise.

Combining the results of all world regions yields a net fall of around 0.5% in global GDP – equivalent to $ 255 billion - in the first year of higher prices. The loss of GDP would diminish somewhat by 2008 as increased demand from oil-exporting countries boosts the exports and GDP of oil-importing countries.

The main determinant of the size of the initial net loss of global GDP is how OPEC and other oil-exporting countries spend their windfall oil revenues. The greater the marginal propensity of oil-producing countries to save those revenues, the greater the initial loss of GDP. Both the IMF and OECD simulations assume that oil exporters would spend around 75% of their additional revenues on imported goods and services within three years, which is in line with historical averages.

However, this assumption may be too high, given the current state of fiscal balances and external reserves in many oil-exporting countries. In practice, those countries might take advantage of a sharp price increase now to rebuild reserves and reduce foreign and domestic debt. In this case, the adverse impact of higher prices on global economic growth would be more severe.

Higher oil prices, by affecting economic activity, corporate earnings and inflation, would also have major implications for financial markets – notably equity values, exchange rates and government financing – even, as assumed here, if there are no changes in monetary policies:

International capital market valuations of equity and debt in oil-importing countries would be revised downwards and those in oil-exporting countries upwards. To the extent that the creditworthiness of some importing countries that are already running large current account deficits is called into question, there would be upward pressure on interest rates. Tighter monetary policies to contain inflation would add to this pressure.