AMMAN, 31 May 2004 — It appears that the era of low oil prices has came to an end. Oil has risen to over $40 a barrel, something that no one had expected just a few months ago. The factors behind the surge in prices include, higher world demand especially from the US and China, worries about the security of supply from the Middle East region, strong buying by hedge funds and the unexpected strength of OPEC. Taken together, all these factors could spell a new era of higher oil prices.
Oil prices are, of course, volatile and it would be very difficult to predict where they are heading. Nevertheless, not only has the average Brent crude kept above $24.5 a barrel for four years running, but the whole oil price futures curve has moved up. Average Brent crude prices per barrel were $28.4 in 2000, $24.5 in 2001, $25.0 in 2002 and $28.6 in 2003. The price for delivery as far as 2010 is now close to $30 a barrel. This shows that the long held belief for long-term oil prices to stay in a range of $18 to $24 a barrel has been abandoned. In fact, in an April 27 speech, the US’s Federal Reserve Chairman Alan Greenspan noted that the long-term oil future market suggests that oil prices are going to stay firm for several years to come.
Most of the upward pressure on oil prices is the result of increases in demand and potential supply disruptions that are unlikely to disappear any time soon. On the demand side, the strong economic growth in the US and the record sales of sport utility vehicles (SUVs) have helped push up consumption by more than 4.6 percent over the past year. China, like many other developing countries, has become much more dependent on oil in recent years as their economies have moved from agriculture to heavy manufacturing. In fact china has just past Japan to become the world’s second largest oil consumer, and its demand for oil which grew 10 percent in 2003 is expected to increase by 8 percent this year, or the equivalent of 350,000 more barrels a day. With the economic recovery in Japan and Europe picking up momentum, the International Energy Agency (IEA) is forecasting a net rise in world demand for oil of 2 million bpd this year, the largest annual increase since 1988.
Another factor propping up oil prices is the supply disruption risk. Political troubles in Venezuela, Nigeria and Indonesia have always undermined market’s confidence in the security of supply from these countries. A bigger aspect of the supply disruption risk is the fear of terrorism that might be targeted at oil infrastructure, especially in Iraq whose exports had frequently been disrupted in the past few months. For now, Iraq is producing 1.5 million bpd below the 2.2 million bpd of last year when it was exporting under the UN sponsored oil-for-food program. There is a new worry that any attack, however small, on Saudi oil infrastructure would have a noticeable impact on oil prices. Saudi Arabia has more than 70 percent of the world’s spare capacity, or close to 2 million bpd.
Speculative investors have also been blamed for the rise in oil prices. By May 25, 2004, it is estimated that hedge funds were holding contracts worth more than 111 million barrels of crude oil in the future market, an indication that these investors expect oil prices to increase further. By historical comparison contracts held by hedge funds worth 60 million barrels or more were considered “very big”.
The long-term is equally supportive of higher oil prices. According to the IEA, world demand for oil is forecast to rise more than 50 percent by 2025, to 120 million bpd, from 82 million bpd in 2004. China alone is expected to import as much oil as the US does now. There is little political will on the part of the major consumers to push for conservation. Even if they do, this will slow the growth in demand but will not reverse it. On the supply side, the Middle East producers, who currently account for about 28 percent of global production are set to increase their share to 44 percent by 2025. Saudi Arabia alone sits on about a quarter of the world’s proven reserves, followed by Iraq and the other Gulf states. On the other hand, the big oil reserves found in the 1970s in the North Sea and Alaska are on the decline and OPEC’s output has increased only marginally in the past three decades to reach 27 million bpd recently.
According to the IEA, demand for oil from the Gulf is likely to double in the next decade, with demand for Saudi oil exceeding 15 million bpd in 2015. This would encourage the oil producing countries of the region to expand their production capacity and boost output. Real GDP growth rates in the oil sectors are likely to rise. Higher oil prices and production levels will allow governments to pursue expansionary fiscal policies generating ample real growth in the region’s public sectors. Private sector activities in the Gulf will also do well, especially those propelled by strong population growth such as wholesale and retail trade, manufacturing, transport, telecom, housing, banking, health care, education and finance.
The non-oil Arab countries, such as Jordan, Lebanon, Syria, and Egypt, will benefit from the spillover effect of strong economic growth in the Gulf countries. Rising regional tourism, higher remittances of Arab expatriates working in the Gulf, more exports to the booming GCC economies and increasing capital inflows from the Gulf seeking investments in the non-oil Arab countries will help support stronger economic growth conditions there. The revived business confidence will encourage more repatriation of funds from abroad and reduce capital outflows. This will boost domestic levels of liquidity and reflect positively on the local stock markets and the countries’ fiscal and balance of payment positions.
Businesses inside and outside the region are now factoring into their future investment decisions the fact that the new era of higher oil prices will put the economies of the region on a higher growth path. This does not mean that the region will not experience the usual short term up and down cycles, but its long-term real GDP growth is now distinctively higher than what was forecasted one year ago. The political uncertainty associated with chaos in Iraq and Palestine and the activities of extremists here and there cannot be dismissed, but it would be a mistake to defer investment plans on the basis of the present risk profile. Reform measures are being introduced, at a slower pace in some Arab countries than in others, but their positive impact on the economies of the region will start showing in the coming few years. Companies who understand the region are positioning themselves for major expansion plans in anticipation of strong market growth.
(Henry T. Azzam is chief executive officer at Jordinvest.)
