International oil prices are surging due to the Middle East crisis. The spot price of Dubai crude, the primary benchmark for South Korea, has more than doubled compared to pre-crisis levels. This reflects supply disruption concerns stemming from the potential blockade of the Strait of Hormuz. The Strait of Hormuz is a critical chokepoint through which approximately 20% of daily global oil consumption passes in the form of crude oil and petroleum products, accounting for roughly 30% of the world's seaborne oil trade. This price spike is assessed to far exceed the shock of the 2022 Russia-Ukraine war, and uncertainty surrounding oil supply and prices has intensified significantly depending on how the Middle East situation unfolds.
As international oil prices surged, domestic petroleum product prices also rose sharply. The government is reviewing and implementing a range of policies to ease the burden on economic actors, including imposing price caps, expanding fuel tax cuts, providing direct consumer support, securing alternative crude supplies, and controlling petroleum product exports. Among these, the petroleum product price cap appears to be the most impactful policy at present. The government launched price caps on gasoline, diesel, and kerosene based on refinery supply prices starting on the 13th of this month and announced a second round of maximum prices on the 27th.
A price cap is a system that sets a ceiling below the market price, serving as an effective policy tool to mitigate economic shocks from price surges. Additionally, while international oil prices can fluctuate daily, maximum prices are adjusted on a biweekly basis, functioning as a mechanism to regulate the speed at which international price changes are reflected in domestic supply prices. On the other hand, price caps are generally known to cause excess demand and reduce the volume of products supplied to the market. Although crude supply constraints call for reducing petroleum product demand, price caps can instead act as a factor that increases consumption. Refiners may also cut petroleum product supply if they fail to earn an adequate level of profit. To minimize these side effects, the government is preparing retroactive compensation measures for refinery losses and is simultaneously implementing demand management policies such as a vehicle alternate-day driving system to curb petroleum product consumption.
The rationale for government intervention in the market through mechanisms like price caps is clear. While markets operate efficiently under normal conditions, market failures can emerge during emergencies such as wars, delivering significant shocks to the broader national economy. A surge in oil prices triggered by a large-scale supply shock, as in the current Middle East crisis, reduces household real income and raises corporate production costs, burdening both inflation and economic growth. The two oil shocks South Korea experienced in the 1970s, which simultaneously inflicted high inflation and low growth on the economy, illustrate this well. Ultimately, the current price cap should be understood as an emergency policy tool by the government, designed to moderate the intensity and speed at which international oil price shocks are transmitted domestically, thereby cushioning the abrupt impact of rising consumer costs and production expenses.
However, the price cap should be utilized as a short-term and emergency policy measure. According to government figures, South Korea has approximately 190 million barrels of oil in reserve, equivalent to 208 days of supply by International Energy Agency (IEA) standards. Yet given that South Korea's dependence on Middle Eastern oil stands at 65%, a prolonged supply disruption caused by geopolitical crisis in the region is highly likely to lead to domestic oil supply instability. In such circumstances, maintaining artificially low prices over the long term may not be appropriate when oil demand reduction is needed, and it must be kept in mind that this could amplify the oil supply crisis over time.
This crisis once again demonstrates how critical peacetime preparedness is for energy security. To enhance response capabilities during resource security crises, adequate reserve levels must be steadily maintained, and policies to diversify crude oil import sources must be consistently pursued. At the same time, long-term policy efforts should be directed toward reducing demand for oil itself, which can be classified as an energy source carrying very high geopolitical risk. While oil demand for raw materials is difficult to replace in the short term, oil demand for transportation can be gradually reduced through the expansion of eco-friendly vehicles and improvements in automobile fuel efficiency.
The current Middle East crisis will deliver a negative shock to South Korea's economy, but I believe it will also serve as an important opportunity to review the energy security framework, identify vulnerabilities, and discuss policy improvements. I hope that rational policy alternatives will be developed that wisely overcome the supply chain crisis triggered by the Middle East situation while reducing energy security costs and strengthening economic security over the long term.