Supply
and demand
While the market
appears to be balanced today, the US government is convinced
that an increased production would lead to lower prices. However,
the Saudi government's announcement that they would increase
production from 9.5 million to 10 million barrels a day did
not contribute to any dampening of the prices.
The world's largest
producer and exporter fears that if the prices maintain themselves
at levels above $100/barrel, that the present recession will
deepen leading to a downward price spiral that would lead
to a significantly lower income for the producing countries.
They also fear that a further drop in the American currency
would severely affect the Saudi kingdom's reserves. An even
worse threat is that a stabilization of oil prices at a high
level would spur the introduction of biofuels that would replace
oil in a significant manner.
Not everyone,
though, is convinced of the ability of the Saudi kingdom to
increase its production levels in a sustainable manner.
The country has,
until recently, been loath at opening new deposits as forecasting
market demand is extremely difficult in the oil market. Some
of the Saudi deposits may well contain high sulphur or heavy
crudes that are difficult to sell.
Saudi Arabia
plans to open the Khurais complex by 2010 - the first major
oil field opened in the last 40 years - at a cost of $15 billion.
This sum is small compared to the investment that would be
required to develop Saudi's potential offshore field.
Other countries
too have difficulty in increasing, or even maintaining, their
capacity. Thus, Russia, which accounted for 80% of the growth
of supply from non-OPEC countries over the last few years,
seems unable to maintain its present production level and,
for the first time in the last ten years, production in the
country fell. Mid-term prospects, however, are optimistic
as new Siberian fields are put into production. However, global
warming is affecting drilling activities in Siberia as the
lack of ice makes it difficult to transport equipment as roads
are non-existent on many areas.
Major investments
are required to keep production at present levels. They are
estimates at $1 trillion over the next 20 years for Russia
alone.
Other non-OPEC
countries, such as Mexico and Norway, have also been unable
to sustain production levels.
More generally,
production in a large number of countries is decreasing due
to the age of the wells. This has led to a widespread belief
in the theory of a peak in crude oil production and discovery.
The peak oil
theory was first expounded in 1956 and its inventor, Mr Hubert,
stated that US oil production would peak in 1970 - and it
did.
Not everyone
agrees, and among them the world's leading oil consultancy
- CERA. Some experts believe we are not running out of oil,
but out of production capacity for a variety of reasons such
as lack of investments and trained manpower.
Another important
set of actors weighing on the crude oil market, and they are
new compared to the traditional actors in previous oil crises,
are the car drivers of the emerging economies, such as China
and India, that have access to subsidized gasoline and who
are therefore relatively unaffected by major rises at the
pump and have thus no incentive to save fuel. Demand is increasing
faster in countries with high subsidies. China alone will
spend this year around $40 billion to subsidize the price
of gasoline.
Indeed, the major
imbalance today is on gasoline rather than crude. Refineries
prefer light oil - used to produce petrol and diesel - to
heavy oils that goes into the production of fuel oil used
mainly for heating.
Iran, for instance,
a major producer of heavy oil, stocks large quantities, that
they are unable to sell, in vessels moored offshore.
Price increases
in the retail market will probably lead refiners to increase
their investments to treat heavy oils, and this may well decrease
prices by increasing availability at the pump.
As prices of
oil rise, oil producers invest some of the funds locally,
expanding the economy, and thus their own oil consumption,
leaving a smaller part of their output available for export.
This, in turn, leads to price increases.
Prices at the
pump in oil-producing states, with the notable exception of
Norway, is usually tax free - it is, for instance, of US$0.20
per gallon in Venezuela - and this leads to a fairly unrestrained
consumption, further reducing quantities available for export.
Even though China
and India have recently increased the domestic sales price
of petrol which remains, however, highly subsidized.
The elements
above are exacerbated by more fundamental issues such as a
lack of qualified petroleum engineers and a need for new infrastructure.
Recent graduates from emerging countries are arriving on the
employment market but essentially join national companies
in their own countries rather than joining one of the majors.
The actors
Among the biggest
players on the oil market today, are the so-called 'new 7
sisters' which are Aramco, CNPC, Gazprom, NIOC, Petrobras,
Petronas and PdVSA.
Banks and other
financial institutions such as hedge funds are also major
players on the futures markets with the oil producers accounting
for less than half the volume. More specifically, index funds
attempt to beat certain indexes and therefore need prices
to increase. The total volume invested in index funds has
grown 20 times over the last five years. They see oil as a
refuge from a weak dollar.
This has led
some political leaders from US presidential candidate Barack
Obama to India's Petroleum Secretary to ask for the halting
of oil futures trading, which they believe to be manipulated
by the speculation from large institutional players. This,
however, is most unlikely to happen. US regulators also consider
imposing limits to trading positions, including on those taken
by US investors on foreign markets.
A number of politicians
have blamed 'speculators' who are switching their holdings
from traditional assets such as stocks and bonds to oil futures,
particularly on the NYMEX - the New York Mercantile Exchange.
Indeed, the number of trades is twenty times bigger than it
was five years ago. This represents eight times the imports
of the US. However, it is not clear if speculative action
is responsible for the increase in prices or rather if the
increase in prices has driven speculators to the market.
The US is about
to introduce legislation that would limit the positions that
investors can take on futures markets.
Comparisons have
been made with other commodity markets where increased activity
is uncorrelated with price movements. Further, some commodities
that are not traded on futures markets have risen even more
abruptly than oil. Oil future traders do not take delivery
of physical product and therefore cannot weigh on prices as
they do not hoard product.
The US
dollar
US imports and
consumption are responsible for a massive transfer of capital
from the US to the oil producing countries, in particular
to OPEC countries which supply 40% of the world's oil.
The drop of the
US dollar against all convertible currencies has been a contributor
to the price increase of the barrel of oil, producers seeking
to maintain a stable price in their domestic currency.
Every increase
in interest rates on the Euro led to an almost immediate increase
in the price of oil, in parallel with a drop in the dollar.
The OECD scenario
forecasts that the share of OPEC countries in global production
will increase from the present 40% to 52% by 2030. Should
the price of oil keep rising, this would translate into substantial
increases in the flow of funds towards the member countries.
The fall of the
dollar translates into lower income in national currency for
the producing countries. Nevertheless, the rise of the oil
prices has fueled an economic expansion in the Gulf and attracted
more foreign workers. Due to a shortage of living space, this
has, in turn, driven up rents and consequently inflation.
Since the currencies
are pegged to the dollar, the oil producers in the Gulf are
not free to apply an anti-inflationary policy as it would
increase the value of their currency.
Kuwait has already
pegged its own currency to a basket. The risk is a run on
the dollar as sentiment against the currency builds.
Seen from the
eyes of buyers, countries with currencies appreciating against
the dollar may well be tempted to build stocks.
A global economic
crisis would reduce oil needs and dollar flows from the US,
thus strengthening the currency.
For the present,
however, gold, which has traditionally been the traditional
investment product that acts as a refuge against a falling
dollar, fear of political disruption and inflation has been
replaced replaced, by oil.
Geopolitical
factors
The geopolitical
factors include the political situation in Iran, Iraq and
Nigeria, resource nationalism, sea lane security, the risk
of terrorism as well as climate change.
The major fears
are, of have been, in the recent past:
Club
of Amsterdam Journal.
