First published in the Independent on Sunday, 25 May 2008
Never mind speculation, forget the weak dollar. To understand the soaring oil price you need only glance at figures from the US government which show that global oil production has been essentially stagnant – at just under 86 million barrels per day – since early 2005. Despite soaring demand, production outside OPEC has been persistently disappointing as international oil companies struggle to maintain production from ageing fields, while OPEC has been unwilling or unable to raise its output. The result is $135 per barrel – for now. To many this suggests that global oil production has already reached its geological limits, or ‘peak oil’.
If supply is constrained, then the variable that will control the price is demand. Since the economy seems to be moving rapidly into recession, conventional thinking would suggest that falling demand for oil should soon bring the price down again. But few traders are betting on that, because oil market dynamics have changed.
In the OECD countries oil demand has in fact been falling for the last two years – but without moderating the price of crude. That’s because of booming demand from countries such as China, Russia and the OPEC producers, where fuel is deeply subsidized and consumers shielded from the soaring price. For the first time it seems that steeply rising fuel prices can co-exist with recession in the West. There are three ways this new situation could play out:
Oil price collapse.
This could happen if fuel subsidies were suddenly scrapped in developing countries and among the OPEC producers, so dousing demand. Cost pressures have forced Malaysia, Indonesia and Taiwan to cut energy subsidies, but China – with $1.7 trillion in foreign exchange reserves – is hardly strapped for cash. OPEC producers are under no pressure to abolish subsidies; as the oil price rises they get richer. Prospect: very unlikely.
The price could also collapse if peace breaks out in Iraq, the long disputed oil law is agreed, and the international oil companies get to work on the biggest collection of untapped supergiant oil fields in the world – which was clearly the intention behind the invasion. Prospect: vanishingly unlikely.
Oil price stabilizes or moderates.
If the combined effects of the oil price and credit crunch plunge the West into a deep recession, this might cut oil our consumption enough to offset growth in the developing world and OPEC and soften the oil price. Or if the recession engulfs the developing countries and trims demand there too. Prospect: unlikely in the short term.
Oil price charges to $200.
If production stays flat and demand in big producer countries continues to boom, export capacity will soon start to be cannibalized. Analysts CIBC predict that exports from OPEC, Russia and Mexico will fall by 2.5 mb/d in the next 5 years, and this will push oil to $200 by 2012. Prospect: highly likely.
Any hint of further problems on the supply side will supercharge the oil price rise. In recent months Russian oil output has gone into decline, Saudi Arabia has shelved all plans to expand production capacity past 2009, and advisors to the Nigerian government predicted that the country’s oil and gas output will fall by 30% by 2015. Any more news like this and the trip to $200 oil could be nauseatingly quick. Prospect: likely.
British government’s forecast
Despite all this the British government’s considered opinion is that oil will cost just $65 per barrel in 2010 and $70 in 2020. This is the government’s ‘central forecast’, but a return to these prices is highly unlikely without an economic slump. Absurd. But then Gordon Brown apparently understands so little about the world oil market he thinks it a “scandal” that OPEC controls 40% of the world’s oil. It’s the geology, Gordon.