Goodbye, Cru-Oil World (Part One of Two)
Businessworld
What I call the “Third Oil Shock,” stirred by the witches of greed – speculators - has the world in “oil, oil, trouble and toil.” Yet urgently aware of the need to excise itself of that toxic limb – oil dependence - in order to survive, the world is still reluctant.
Until now, the strategic commodity has been the cheapest, most accessible form of energy. As the world comes to grips with oil’s finiteness (graph), fears have led to “Peak Oil” behavior, marked by piecemeal, margin optimizing sales, and speculation. Various experts – like Saudi geologist Sadad Al Husseini - estimate that between 2015 and 2020, oil output will peak, and eventually start declining. This will be exacerbated by demand rising continually, projecting 116 million barrels/day (BPD) by 2030; 30% higher than today’s estimated 85 million BPD.
The supply-demand imbalance is the fundamental reason behind the oil market’s tightness. And with ‘near perfect’ inelasticity of refining supply, and ‘near perfect’ knowledge of peak oil, the current and futures commodities market becomes a speculators’ killing ground.
This in itself is already highly inflationary since oil has a multiplier effect, being a vital component in the production of not just a single good, but its production components as well: power, machinery fuel and oil….
This speculation can be affected by other disturbances. If at the height of the developed world’s globally warmed summer, oil averages at about USD132 per barrel (bbl), would a harsh 2008 winter bring USD165/bbl? Or an attempted oil pipeline terrorist attack, plus USD5?
THE FIRST TWO OIL SHOCKS
The first two shocks, in 1973 and 1979 were caused by man-made production output interruptions in a war torn Middle East. As seen in the graph, prices during the 1973 Yom Kippur War rose 400% (from USD3.00 to USD12.00/bbl) in six months, after a deliberate, 5 million BPD production drop by Arab countries. The 1979 Iran-Iraq war destroyed production capacity of 2.5 million BPD, increasing prices from USD14/bbl in 1978 to USD35 in 1981.
THE THIRD SHOCK
Interestingly, the natural supply was not even a factor. This is where the third shock differs. The 1970s concept of “peak oil,” when combined with Globalization’s capital flows, manufacturing shifts, and increased demand from China and India’s growing economies, the main reason lies bared: speculation.
It matters little that the Saudis are set to provide an incremental of about 2 million BPD by mid-2009, because the consideration is still the end product. Even they blame the short-term price jumps on speculation and shortage apprehensions.
Characteristically, these jumps are caused by “peak” behavior, which is undeniably, a lucrative opportunity. In the past five years, investments in commodities funds have grown from USD13 Billion to USD260 Billion. It’s anyone’s guess as to who holds that money, or how much is poured into the oil market. The G7 countries may harp about the US trade deficit, but the reality is that capital movement liberalization creates massive global imbalances. What is sure is that oil futures markets speculation and hedging have driven prices skyward, from USD100/bbl in October 07, to USD136, in June 08.
Diesel is a main culprit as various circumstances – like increased sulfur standards yielding less diesel from a barrel of crude, to China running factories with it, or that more European cars use diesel – have sent demand soaring. Since Diesel offers a greater spread (up to USD32/bbl), compared to gasoline (offering only USD6/bbl), refiners are gobbling up crude stocks, further pushing up demand.
OIL PRICES, INVERTED YEILDS
These rampant Oil prices, whether caused by fictional or actual shortages, and the speculation that follows, causes dire, and in a tightly-knit economy, global, inflation. The world economies will respond with fiscal controls, primarily interest rates, thus risking double jeopardy. As high interest rates mop – up liquidity, the economy runs the danger of stagnating, as the dour fiscal mood induces conservative business behavior.
The situation may precipitate a condition known as inverted yield, where the projected higher returns on long term investments are given up in favor of lower, short term yields, in anticipation of a worsening, long – term economic outlook.
SELF-CORRECTING MECHANISM
Ironically, oil’s high price is its own self-correcting mechanism. For one it automatically curbs excessive, unnecessary demand. More importantly, as in the past shocks, it forces the world to seek alternatives.
Today’s need is certainly more urgent, because aside from an oil shortage, there is global warming, and food scarcity, all linked in some way. The developed countries are beginning to reconfigure their energy profile – with conservation or innovation - that reduces oil consumption.
In the next article, we will explore how we can combat the ill effects of rampant oil prices, and explore opportunities that the issue presents to the Philippines.
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