Each day brings fresh statistics purporting to show that the last drops of oil are being swallowed up by unstoppable global demand.
What can we make of all this? Ever since the Iraq war became more than just a gleam in the eyes of the neo-conservatives in the Bush administration, I have been forecasting that oil prices will shoot up towards $40 a barrel. I refer readers to my column in March 2003. Then, nearly all the experts reckoned that the oil price would fall back to below $20 once the Iraq campaign was over. Even Opec was cutting its production quotas because it predicted that supply would exceed demand.
Well, the experts and Opec have been proved wrong, because of two things: continued violence disrupting supply in the Middle East, and strong energy demand from China.
As I argued last year, the US administration would be quite right to expect that a victory in Iraq would have a domino effect. But the dominoes fell backwards, not forwards.
Most Arab oil producers suffer from major social and economic imbalances. Their youthful populations face high unemployment and are natural targets for a form of Islam whose ideology is anti-economic and will further impoverish them.
Not all of this mess can be blamed on the Bush administration. It didn?t make the Middle East. History did. But the now discredited neo-conservative policies intensified the destabilization of the region with the silly idea that replacement regimes based on civic society, the rule of law and liberal economics would be rapidly accepted. On the contrary, the US, by winning the Iraq war and losing the peace, pushed Arab youth towards Al Qaeda. And by offering their rulers the choice of democracy or death, they pushed them towards maximizing the oil price for the short term over which their regimes will survive.
This has set in motion a fatal process for the House of Saud in particular, which unreformed will survive for less than a decade.
This is the geopolitical case for an expectation of rising oil prices, but the case unfolds over quite a long time. That means oil prices won?t reflect this threat just yet. In the meantime, we can refute some of the more ghastly predictions on oil with two key observations.
First, the claim that oil is running out is bunkum. Second, supply and demand balances rarely set the oil price. Geopolitics does.
Two things catch the eye. First, oil stocks are at above-average levels. Second, the oil
industry might always operate with a tiny margin of spare capacity but capacity utilization is almost the same as when the oil price was $19. So capacity utilization is not a driver of the oil price. The picture from the oil crises of the 1970s is limited temporary cuts in supply but no prolonged supply shortages in markets to drive up prices. The massive price rises were on the back of political crises.
The hype about production bottlenecks is just that. Take the tanker shortage claim. Actually, there are enough ? they are delivering all the oil the world needs. Claims about refinery shortages don?t hold up either. They merely set the margin that refiners get on top of the crude price. They don?t set the latter.
Then there is the talk about China?s insatiable appetite for oil. In fact, China increased its oil consumption by about 1.3 million barrels a day between 2000 and 2003 but still takes only 7% of global output, compared with 6% in 1999. That's because increased consumption was dwarfed by a rise in Russian oil output of 2.5 million barrels a day during the same period. And China is about to have a slump that will cut its demand for oil and other commodities so beloved of speculators.
What does all this mean? First ? short of the collapse of the House of Saud ? oil prices have peaked. Second, there will be a positive inflationary surprise from falling oil and commodity prices in the autumn. This might give equities their last shot at new highs, because high growth and good profits will coincide with waning fear of increased interest rates and inflation. Even bonds might rally.
Third, I think the story will be pro-dollar because the US will be seen to be, at the margin, the best transformer of lower commodity costs into higher profits for investors. And lower oil prices will help the US?s external deficit. So enjoy the rally while it lasts.
US & OECD Europe
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Supply and demand
Chinese
demand and former USSR
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