The
predicament in Europe has thus far diverted attention
from another crisis that has been brewing for some
time now: a spike in global oil prices. The price
of oil has risen by close to 20 per cent since the
beginning of this year, raising the prospect of it
touching the peak levels it had reached in July 2008.
Brent Crude was selling at $128 a barrel at the beginning
of March, as compared with its less-than-$110-a-barrel
price at the end of December (Chart 1). This spike
occurred on top of the continuous increase in prices
recorded since December 2008, when oil prices touched
a low influenced by the global crisis. Prior to that
the free-on-board (FOB) price of Brent crude had collapsed
from more than $140 per barrel in July 2008 to less
than $35 a barrel by the end of that year. But though
the recession has persisted even after that, the price
trend has reversed itself to reach its current high
levels even by historical standards. In fact, if Europe
was not experiencing the stagnation it is struggling
to address, oil prices could possibly have been at
another record high.
Chart
1 >>
(Click to Enlarge)
From a purely demand-supply point of view, the rise
is indeed surprising. The US, the world's largest
importer (Chart 2), has seen its import levels drop
significantly. One reason is that the combination
of a recession and higher oil prices has restrained
oil demand. According to official sources, the demand
for oil in the US was down by 2 per cent last year.
In addition domestic supply has improved, partly because
of increased domestic production and partly because
of the availability of alternative fuels such as ethanol.
As a result the share of imports in US oil consumption
was down to 45 per cent from 60 per cent in 2005.
Aggregate US imports of crude oil are placed at 8.91
million barrels a day in 2011, which was the lowest
it has reached after 1999. All this should have worked
to moderate international oil prices.
It could be argued that the fallout of these trends
in the US has been partially countered by the increase
in Asian demand. China and India are the second and
fourth largest net importers of oil. But in their
case too growth, though higher than in Europe, the
US and Japan, has slowed after the crisis. So demand
from those sources too would have been lower than
would have otherwise been the case.
Chart
2 >>
(Click to Enlarge)
If prices have risen sharply despite these trends,
it is principally because of the uncertainty resulting
from political developments in the region. Ever since
the outbreak of diverse oppositional movements in
West Asia and North Africa, uncertainty with regard
to supplies has been on the rise. The political disruption
in Libya in particular was seen as having had an adverse
effect on supplies. But the factor that seems to have
provided a fillip to the price rise was the standoff
between Iran and the West, ostensibly over the former's
nuclear programme. Iran, which is third largest net
exporter of oil (Chart 3), is already subject to US
sanctions that are targeted at limiting its oil exports.
In fact, in recent times, the US has intensified its
efforts to discourage global consumption of Iranian
oil. To add, Europe announced that it would also impose
an embargo on oil imports from Iran starting from
July this year, and Iran responded by threatening
to immediately cut supplies to six European countries.
The price spike, however, was not because of any immediate
shift in the supply-demand balance and shortfall in
oil availability resulting from these factors. To
start with, the announced European embargo and Iran's
response to it have yet to be implemented. Secondly,
the US has not been able to persuade all countries
to stop oil imports from Iran, which would have effectively
cut off its supplies to world markets. A typical case
here is India. India imports around 300,000 barrels
of oil a day from Iran, which amounts to a significant
share of its oil consumption. Yet India seemed to
be succumbing to pressure from the US, first with
respect to a transnational pipeline project involving
Iran and subsequently with regard to foreign currency
payments arrangements for Iranian oil. But finally,
India has worked out a rupee payment deal, which secures
its supplies from Iran as well as opens up opportunities
for trade reminiscent of India's relationship with
the erstwhile Soviet Union. Besides India's action,
Iran's supplies to the world market are likely to
remain untouched because of the importance of Asia
in its total exports. China, India, Japan and South
Korea account for more than 60 per cent of world imports
of Iranian oil. So long as these countries protect
their own energy security by not cutting off their
relationship with Iran, a chunk of supplies involved
in the global trade in oil would not get cutoff.
Chart
3 >>
(Click to Enlarge)
Finally, as in the past Saudi Arabia has helped cool
oil markets with its spare capacity and its willingness
to ramp up production to cover any unmet demand. Saudi
Arabia had made an important contribution to reining
in oil prices during the Venezuelan oil strike in
2003, the invasion of Iraq in 2003 and the Libyan
crisis last year, and promises to continue to do so.
If despite all these factors that keep the supply-demand
balance in control, prices have risen, it is because
of the speculation engaged in by global finance by
exploiting the prevailing political uncertainty. It
is known that energy markets have attracted substantial
financial investor interest since 2004, especially
after the decline in stock markets and in the value
of the dollar. Investors in search of new investment
targets have moved into speculative investments in
commodities in general and oil in particular. Hedge
funds and other investors have been buying into the
commodity, fuelling the price increase even further.
The problem is that this consequence of speculation
is not just a short-term price spike. If speculation
feeds on political uncertainty, then we could be looking
at a long-term problem in oil markets. As noted earlier
(Chart 1), looking back it emerges that nominal oil
prices were rising gradually from 2003 till the middle
of 2006 and sharply from early 2007 till the middle
of 2008, after which we have witnessed the dip and
revival since 2008. That is, the last decade, when
political turmoil intensified in the West Asian region,
has been a period of an almost continuous increase
in oil prices, irrespective of the state of global
demand.
Chart
4 >>
(Click to Enlarge)
This is by no means a normal inflationary trend, since
even the real, consumer price inflation-adjusted price
of oil has been at high levels in recent years. Consider,
for example, the price of oil imported into the US,
measured in inflation-adjusted terms or in ''2012
dollars'' (Chart 4). The chart shows that the real
price of oil has been on the rise since 1999 and especially
since September 2001, when the US responded aggressively
to the twin towers attack. What is more, the peak
2008 price in 2012 dollars was above the high prices
recorded in the 1970s, which was when the world experienced
the effects of the formation of OPEC, the Iranian
revolution and the Iran-Iraq war. In sum, ever since
''9/11'', oil prices have not just been on the rise
but seem to have found a higher average level when
compared with trends since the formation of the OPEC
cartel.
It has been known for sometime that this long-term
trend was not really the result of fundamental demand-supply
imbalances but driven by financial speculators exploiting
political uncertainty. In April 29, 2006 the New York
Times had reported that: ''In the latest round of
furious buying, hedge funds and other investors have
helped propel crude oil prices from around $50 a barrel
at the end of 2005 to a record of $75.17 on the New
York Mercantile Exchange.'' According to that report,
oil contracts held mostly by hedge funds had risen
to twice the amount held five years ago. To this had
to be added trades outside official exchanges, such
as over-the-counter trades conducted by oil companies,
commercial oil brokers or funds held by investment
banks. And price increases had also attracted new
investors such as pension funds and mutual funds seeking
to diversify their holdings. In fact, in November
2007, when Royal Dutch Shell, Europe's biggest oil
company, presented its third quarter results, Chief
Financial Officer Peter Voser argued that: "The
price (of oil) seems to be driven by some speculation
and also has a political premium in it rather than
actually some of the fundamental drivers." These
trends have only intensified since.
Not surprisingly, in 2008 the Organisation of the
Petroleum Exporting Countries (OPEC), which is normally
held responsible for all oil price increases had asserted
that oil has crossed the $100-a-barrel mark, not because
of a shortage of supply but because of financial speculation.
OPEC's contribution was indirect and unintended if
at all. As A.F. Alhajji, Energy Economist and Associate
Professor at Ohio Northern University had argued in
the Financial Times, even when some OPEC countries
are to blame it is because: ''As oil prices have increased,
so have their (OPEC countries') revenues. Some of
these revenues found their way into funds that speculate
in oil futures.'' In his view, it was in this way,
ironically, that ''petrodollars'' have helped drive
oil prices to record levels.
In sum, a combination of political uncertainty, partly
generated and sustained by US and European foreign
policy, and the operations of global finance, has
taken the world into a higher oil price regime. Such
uncertainty and the accompanying speculation hold
out the threat of an age of ''high oil''. We seem
to have forgotten that. But recent developments are
once again bringing that truth to the forefront.
*This
article was originally published in the Business Line
on 5 March 2012.
