The price of crude oil is hovering at the $90-$100 a barrel, up almost $40 since last year, but energy addicts are not always put off by high prices. Sometimes the cost of a drug makes the craving more dangerous. There are now worries about a global economic downtown, and if sustained, current high oil prices will have a negative effect, especially in the US.
However, as was the situation in the late 1970’s, the real problem with oil’s current price is not that it is too expensive, but that it still much too cheap. In real terms, as discussed during the recent OPEC summit in Riyadh, the price of oil is around 1980’s price levels. Countries, such as those in Europe or the UK, that buy oil in dollars, have also seen their purchasing power in terms of oil increase, making oil cheaper.
The world is trying to find other sources of energy and use less carbon-based fuel, as well as exploiting carbon-based fuel more efficiently. Putting the price up steeply is one way to encourage such an energy shift. No politician around the world would have dared impose around a 40 percent increase on the price of oil under a year, but international market forces have done it.
It will be naïve to think that the world’s energy consumers will be weaned off their oil addition in the short run, as new-technology renewable sources make up only 0.5 percent of the global energy supply and fossil fuels will continue to be essential for the long time. But current high oil prices do not seem to be a reflection of fundamentals of demand and supply, as one OPEC Minister after another point out that the world’s demand for oil is being adequately met.
Critics suggest that speculators are inducing an oil-filled bubble, helped by external factors — geopolitical tensions and technical factors such as refinery shutdowns and industrial action.
The second element in the volatile mix has been the problem of real estate markets around the world. Against an international backdrop of rising commodity prices and steadily increasing inflationary pressures, there has been a noticeable burst of property speculation, and Saudi Arabia has not been immune to this, as latest inflation indicators point to real estate price rises as being one contributory factor.
According to SAMA, rent costs have jumped 11 percent compared with 7.2 percent for food for the period ending September 2007. Just as today, the earlier 1970’s real estate boom was brought to a halt by rising interest rates, resulting in a credit crunch, with central banks now scrambling to cut back on interest rates to avoid a financial domino effect to secondary financial institutions, as the UK’s Northern Rock depositor panic reaction showed.
Given uncertainties about financial market conditions, and a slump in consumer confidence, house prices are beginning to slump across both side of the Atlantic. In the US, house prices have fallen by 4.5 percent in the last quarter, and 1.7 percent in the previous quarter — the biggest quarterly drop in 21 years. There are some who doubt that the recent Fed rate cuts will manage to revitalize US. home demand any time soon. Buyers will continue playing the waiting game, with some forecast that at current sales, it will take a massive 10 months to clear current housing supply.
If the US recession deepens, and jobs continue to decline, this could put more pressure on confidence and increase the likelihood of a recession. Should this happen there is bound to be some knock-on effect on the barely recovering credit markets, with the probability of still tighter lending criteria, higher market interest rates, and yet more demand for emergency central bank loans. What is making crystal-ball gazing over interest rates, house prices and oil prices even more difficult is that globalization has changed the name of the game. What happens on the streets of London, New York or Paris in terms of real estate no longer depends on the actions of central banks in these countries, but also on events in Beijing and Delhi. Low cost industrial goods from China, and outsourcing of services to India, have resulted in lower inflation, probably lower world interest rates, and one of the most remarkable and benign set of global economic conditions since the 1950’s and 1960’s golden boom eras.
Globalization seemed to produce a miracle that equaled lower import prices that equaled lower inflation that equaled lower interest rates, and equaled faster world growth.
However, the sub-prime market has dented this optimism, as investors around the world have realized that free flow capital markets have made the life of central banks to manage domestic economies more difficult. Changing one set of monetary tools for another is still a central bankers’ prerogative, but they are becoming less confident about what the outcome will be.
For investors in the Gulf, boom-bust stock market cycles, creeping inflation, exchange and interest rate uncertainties, whether driven by domestic considerations or through international linkages, is transmitting itself in the real estate market, some segments of which are overheating. However, real estate, especially in prime areas such as in Makkah and Madinah are desired by investors , as demonstrated by the strong gains in the Jabal Omar IPO in the Saudi market.
However, it will be interesting to see what effect a reduction in oil prices will have on the real estate market in general in the long run.
However, unlike the property price slowdown in the US, and now the UK, a large element of current real estate and rental price rises in the Kingdom and the Gulf is genuinely driven by supply shortages due to oil-induced construction booms.
Oil once again, is a central player in determining the volatile mix of the equation between property and inflation in the region.
(Dr. Mohamed Ramady is a visiting associate professor, Finance and Economics at King Fahd University of Petroleum and Minerals)