Last November, in an interview with this newspaper, I made a comment that the rising oil prices will be a big drain on both big and small economies of the world and, as demand increases while supply remains constant, the price of oil is bound to stay high. I underestimated the growth trend: Oil prices are now breaking new barriers! Let’s face it oil strategists were contemplating a price hike earlier this year to $80 a barrel (and some went as high as $100) within a 12 months period.
Yet despite these early warning predictions, industrial countries failed to control their excessiveness. The basic tenet of supply meeting demand remains a valid indicator for both production and price stability. But what is happening in the real world of today, defies all rudiments and further complicates this stability.
I challenge anyone who professes to be an expert to give a rational assessment on the global energy situation with a semblance of certainty the markets expect. Excluding natural disasters, like Hurricane Katrina and the Tsunami, etc., price of oil will continue to creep up for the foreseeable future and, unless someone presents a cogent argument to the contrary, we will see it climbing quietly higher and higher.
There was one rather interesting predictions made last Tuesday by business publisher Steve Forbes. Forbes boldly predicted that we are going to see oil down to $35-$40 in 12 months! It’s a huge bubble, he suggested, that will eventually pop. According to him, hedge fund speculators in oil futures are getting very active. Consequently, the higher the price goes, the further it falls! I don’t buy this argument and will explain why.
Human nature dictates that we worry, and sometimes panic, when confronted with uncertainties and fears and to naturally avoid taking any high risks. In its reaction to the Hurricane disaster, the US government agreed to appease local demand and ease prices for oil by supplying oil from the Strategic Petroleum Reserve (SPR).
Initially, prices slipped briefly after this announcement, but then resumed its climb. I recall last July the US economy showed an expansion strong and confident enough to tolerate $50 a barrel of oil.
Jitters were felt as price climbed to $60 and now at $70! The repercussions will probably be most worrying and the Fed would inevitably need to re-review its short-term interest rates policies. Otherwise, I believe the boost to growth expected from the corporate sector could simply evaporate notwithstanding the Fed’s recent interest rates policies.
The dynamics of the oil markets are changing so rapidly that it is worth a consistent assessment of its stability and volatility. My approach is simply to examine numbers and they must add up. If they mathematically do not, then something is unequivocally wrong.
Global oil demand is expected to increase by 1.8 million barrels per day this year and yet we see evidence of falling production on the supply side. The large oil producing countries of Russia, Mexico and possibly Saudi Arabia, are showing signs of peak production and other countries such as the United Kingdom, Norway, and Indonesia output is declining even more rapidly than expected. Recent estimates indicated that the average decline rate of global oil wells is 8 percent. This is a seriously high percentage!
This demand and supply logic is turning ruthless and it poses the greatest perils for the US and world economies. Any disruptions could indeed exacerbate the already edgy no excess capacity situation in market demand and supply, e.g. new damaging hurricanes or other natural disasters; political unrest in certain oil producing countries; slackness in global refining capacity; horrendous acts of terror, etc. These factors could, individually or collectively, cause disruptions in oil supplies and hence havoc on a global scale.
The question then becomes: What sort of emergency plans these growing economies have to cope with shortages in supplies for their energies? I am afraid the answer to this is more or less a skeptical one. The demand would overlook the adequacy and elasticity of supplies and thus push prices higher and higher to new barriers.
As for the United States, even with its SPR stimulus, the stubborn momentum of petrol guzzling at the stations will pressure the government to keep on delivering from its reserves at incremental costs to consumers. When, and not if, the price of oil hits $100 per barrel, economic recession in the US will become inevitable, according to some strategists. How high can oil go? In a crisis, the sky’s the limit!
(Habib F. Faris is vice president at Clariden Bank, London)
