IT takes a plucky writer to admit he is wrong, particularly when there is a
certain type of reader out there – usually anonymous, sometimes using
joined-up writing – who is happy to tell me I am wrong every week.
But I have been wrong, so far at least, on oil. High oil prices, one of the
factors that have complicated the task of the Bank of England and its fellow
central banks, are still with us, having climbed back above $70 a barrel in
recent weeks. Last week they remained close to that level. Futures markets
suggest $60-$70-a-barrel oil for the foreseeable future.
My hopes were raised earlier this year when prices dipped briefly below $50 a
barrel, not far above the $40 level I had said was sustainable in the
long-term. But the market was just teasing, and prices were soon on their
way back up again.
So this is a good time to revisit oil, and to ask the question: Will prices
ever come down again?
America’s “driving season”, which traditionally begins on Memorial Day (last
Monday), is a key date in the oil season. Last summer, high prices had the
effect of curbing so-called VMT (vehicle miles travelled) in America and
prevented the usual seasonal rise in demand that occurs as the weather warms
up.
With petrol prices having spiked higher again, something similar may be in
store. Higher prices do have an effect – American carbon emissions fell last
year.
So what has been pushing up oil prices? International tension, whether it be
the Iraqi insurgency, violence in Lebanon or Gaza or American warships
patrolling off Iran, appears to be ever-present.
With 62% of the world’s “proved” oil reserves in the Middle East, this is an
uncomfortable backdrop. Tensions in the region are worth, on reasonable
estimates, $10-$15 of the current price of crude oil, maybe more. The big
one, of course, would be a serious Saudi insurgency, with attacks on the
world’s biggest producer’s oil installations. Some attacks have been
thwarted by the kingdom’s security services this year.
Tension in the Middle East is one thing but turbulence in Africa has had a
more direct effect on oil output. Political unrest around Nigeria’s
presidential election and the activities of militants in the Niger Delta,
who specialise in kidnapping oil workers, have combined with technical
problems to cut production, at times by 800,000 barrels a day, though a
strike was called off last weekend.
There are other important factors. One reason American motorists are starting
the driving season with petrol prices of well over $3 a gallon (40p a litre)
is the high price of crude. But equally important is the chronic shortage of
American refinery capacity. No new refineries have been built since the
1970s and the oil giants have been fighting congressional allegations of
“price-gouging”, in other words profiteering.
These are all important factors, and there are others. Hedge funds moved money
out of oil earlier in the year but have come back in. Investment demand has
helped to boost prices.
The two most important reasons for the strength of oil prices, however, lie
elsewhere. The first is the strength of the global economy. More than a year
ago, the International Monetary Fund (IMF) spoke of an “extraordinary purple
patch” for the world economy. At that time the global economy was enjoying
its third successive year of roughly 5% growth, its best run since the early
1970s.
The thing about purple patches is that they tend to be temporary. My
expectation of softer oil prices was partly based on a softening of global
growth, perhaps only to 4% but enough to make a significant dent in oil
demand.
But that has not happened, despite weaker growth in America. The world is
still growing at 5%, for the fourth year in a row, and forecasts from the
IMF and OECD suggest something like this will continue next year and even
beyond it. World economic growth of 5% does not mean a 5% rise in global oil
demand but, according to the International Energy Agency (IEA), it does mean
a rise of 1.8% this year, after 1.3% last year. The global economy would
need to slow to below 4% to flatten oil demand. That is possible at some
stage, but for the moment there is plenty of momentum. Some oil-price bulls,
curiously, were growth bears, which never looked very rational.
Demand is one factor, supply the other, and here the finger has to be pointed
firmly at the Organisation of Petroleum Exporting Countries (Opec). The
cartel has got its act together, cutting production, ostensibly to put a
$60-a-barrel floor under prices, in practice to keep prices well above that.
The IEA estimates that Opec production, at just over 30m barrels a day, is
3.7m barrels below its sustainable capacity. Four years ago Opec was happy
to keep oil prices in a $22-$28 range. Then it said it wanted to protect
$50; soon it could be more than $60.
Is Opec, dominated by the Arab oil states, being greedy? Yes. I wish I could
say they would suffer for it. But as long as the world economy is strong,
evidence of “demand destruction” – collapse in demand for oil that would
push down prices – is hard to detect. Some Opec members would no doubt blame
western intervention in the Middle East for high prices.
So what will happen? There are three possibilities. One is that it is onwards
and upwards for prices, each increase in international tension interacting
with tight supply to push us to $80, $100 or beyond. The other is that
$60-$70 is the new sustainable level and that, as the futures markets imply,
we will stay there for some time. The third possibility is that prices will
drop significantly again.
I would still argue, based on the history, that this is too high and that at
some stage, as has always happened in the past, prices will drop
significantly again. But some oil price spikes are short, no more than a
year or two. Some last longer. You could argue that we were in a continuous
spike from 1973 to 1985. This one is getting longer by the day. Until demand
weakens, it will continue.
PS: How worried should we be about a “back to back” rate rise from
the Bank of England this week? We have been warned by both the Bank’s latest
inflation report and the minutes of its May meeting that at least one
further rise is on the way. Those interested in historical parallels will
note that the last time it happened was exactly three years ago, in May and
June of 2004.
The minutes suggested the reason nobody on the monetary policy committee
(MPC) voted for a half-point rise last month was because even those members
who toyed with it were unconvinced and wanted time to assess the effect of
rate rises so far. Other members stressed the need to move cautiously on
rates, while a third group was concerned about triggering a downturn in the
economy. None of this suggested much of an appetite to move again quickly,
though people’s perspectives change, even over a month.
The “shadow” MPC, which meets under the auspices of the Institute of Economic
Affairs, has also been deliberating. It has been more aggressive than the
actual MPC, four of its members urging a half-point rise last month.
This time, the shadow MPC has one “half-pointer”, the former dove Roger
Bootle, who thinks the shock therapy of an immediate move to 6% is needed
because “the stakes are too high to be pussy footing”. Three other members
of the committee – Tim Congdon, Andrew Lilico and my namesake David B Smith
– all want a quarter-point hike this week.
Bootle said there is a danger inflation will get out of control. Congdon now
believes the likely peak in rates will be 6.5%, attacking the Bank’s
analysis of the relationship between the money supply and asset price
inflation as “useless”.
These four were, however, outvoted by five others, Kent Matthews, Patrick
Minford, Peter Spencer, Peter Warburton and Trevor Williams. Even if they
are right this week, however, the Bank will still have to hike again – all
four of the hikers and two of the “holders”, Spencer and Williams, have a
bias towards further tightening.
david.smith@sunday-times.co.uk
Can I ask a simple question? What percentage of the amount paid at the gas pump goes to the oil producers and how much goes into tax?! I believe that will explain a lot of things!
Bander, Dammam, Saudi Arabia
David, why ca't you bring yourself to even mention the term 'Peak oil'? Like so many other pundits, you have wrongly forecast the direction of the oil price these past 3 years and yet are still seemingly oblivious to the possibility that the oil market is in the process of changing forever. The UK/Norway has peaked, Mexico has peaked, to add to the long list of other countries that are now in decline, and there is the real possibility that Saudi Arabia's biggest field has now also peaked. Why is it so hard to comprehend that a resource such as oil is bound by geological not economical constraints? By the way I really think you should write a piece on the implications of the North Sea decline for the UK. Last year the UK became a net oil importer (and will be again this year, despite the modicum of relief provided by Buzzard); this situation is only going to get progressively worse as shown by the DTI's figures (an average 8% decline rate has now set in).
Andy Hamilton, Nelson New Zealand, NZ
Uncertainty about oil reserves, possible crises in the near term, bottlenecks at refineries, speculation, and increased demand certainly account for a large measure of the uptick in oil prices.
James, Jacksonville, Illinois U. S.
OPEC lost their pricing monopoly power during the 1980s when everybody stopped trading spot and started trading "paper oil". There may well be evil cartels manipulating the price of the energy used by the entire planet, but they are in New York, not in Vienna or Dubai. The "market price" for oil is a joke considering that the vast majority of crude trades at prearranged contract prices and not market prices. The cost of gasoline at the pump has far more to do with refinery capacity and storage costs than any geopolitical rumblings.
It does seem to be a bit of a stretch to twist things to blame "the arabs", despite the fact that it is so fashionable these days in this and other fine publications.
GregD, Boston, USA
David did not mention the big unknown factor affecting the future of oil prices - overdeclaration of oil reserves.
In the 1980s, OPEC's claim of total reserves leaped from 353 to 643 billion barrels without a single major discovery.
In the 1970s, when Western managers were still in charge, they believed for a time that Saudi output could reach 20 million barrels a day. But by the time the Americans lost control in 1979, they figured the peak would be 12 million.
They also predicted that peak production would last only 15 or 20 years. That would mean we're past the peak.
Shell as we know was caught out by overdeclaration.
We just don't know how much oil is out there. What we do know is that macho overdeclaration boosts a nation's international importance and a company's share price.
Peter Kellow, Lesneven , FRANCE
High oil prices are a fact of life. Oil producing countries are now "worldly wise" to the power they have over us commercially & socially. Until we find a viable alternative to "drive" industry & transport nothing will change. We just have to live with it
Alan R Gardner, Birmingham, United Kingdom
Was this article really worth writing ? Prices rise and fall according to supply and demand, as Mr Smith says. OPEC is certainly strong in a sellers' market; but when things get tough and prices tumble we have seen little discipline on the ground, despite 'agreements' and fine words.
When nuclear, solar, and other methods, seriously compete with fossil fuels; when a serious recession occurs; then no doubt hydrocarbon prices will fall! Whatever OPEC does!
Until then, as he tells us, they may go up, or down, or sidways.
Robert Sebag-Montefiore, Geneva, Switzerland
the days of the cheap oil are over i,m afraid.
as for what will happen in the future well, the price will go up or it could go down or it might stay the same.
3 possibilities
mike keary, paisley, scotland
Oil is a finite resource. World population is growing at the size of the UK and Australia combined (80m people) per year. About 1 billion people in just 10 years.
ALL the major oil fields are in decline. Ghawar was discovered in 1948 with peak production in 1980. Nearly all production is being discovered offshore. The UK is now an importer. Didn't last us long did it? Most world exporters are in the same position and in decline. Many people are in denial, they cannot accept FACTS.
Saudi Aramco will never allow production to rise above 85 mbp/d again. The consumption of cheap petrol is being used at extraordinary rates in the Middle Eastern countries. They will need as much oil internally just to meet their own demands. Already we are see third world countries rationing electricity due to high crude prices.
We will see bidding wars, rationing and high prices beginning this summer. The west look out.
The lights are going OUT.
Paul Price, Warrington, England
The OPEC cartel's members always cheated in the past when oil was fetching high prices. This is why OPEC couldn't successfully sustain the price. The last oil shock of 1971 exactly matched the peak in oil production of the USA (whose production has declined every year since) so strengthening the hand of middle eastern producers.
David Smith says Saudi Arabia has managed this time to exert discipline on the cartel members. Exactly how? There is no reason why the CARTEL wouldn't secretly exceed production quotas as they have always done in the past.
No- the reason oil is high is that OPEC and everyone else is pumping at full tilt and world demand is rising faster than production capacity. Saudi Arabia is obfuscating on this one by making it seem they are in control when actually world production is incredibly tight. They know the consequences for the marktets if traders sense that there isn't sufficient oil. The price will hit the roof and demand will thereafter collapse.
Dominic O'Dell, London,
You need to get some facts right. According to most people in the know, except the ever optimistic liars at the Cambridge Group in the USA. oil has either peaked or will in 2010/2011. The world cannot produce much more than 84m barrels a day. The North Sea, Mexico, Kuwait, Indonisia have peaked and their output is declining at up to 15% a year. Saudi Arabia's Ghwar oil field, the largest ever discovered in the world is producing more water than oil and has probably peaked. No new mega oil fields have been found for a number of years.
The oil price is not going to fall and will probably within two years be over $100 (especially if it continues to be priced in the ever depreciating US Dollar).
Rumsfeld, London,
One of the Arab arguments for maintaining high oil prices is that European countries insist on taxing oil at a very high rate. This means that many countries ( even almost oil/gas self-sufficient UK) earn more money from oil usage than many Arab countries themselves. The UK could easily lower oil taxes (and thus prices) but it does not! Many oil producing countries keep gasoline prices very low for their own citizens. (USA, Saudi Arabia, Malaysia, Venezuela) The UK does not. You may argue that this is to lower consumption, encourage smaller cars, and reduce pollution, but one suspects these arguments are actually used by the Treasury to raise taxes without regard to oil price consequences. The UK likes high oil prices but keeps very quiet about its policy on OPEC.
Brian Lewis, Manila, Philippines
How comic that 'Death of Inflation' Bootle is the first to panic about its return. Of course, the first to see rates heading towards 6, when everyone thought they were falling to 4, was arch monetarist Tim Congdon. That was 2 years ago at the Lombard quarterly forecast meeting. Deep respect TC.
mark mcfarland, dubai, uae
Paul Price is quite right...
When I read the article I thought: David Smith doesn't get it.
But one must understand that there's a conspiracy of silence going on in Britain and elsewhere between politicians and the media, never to mention 'peak' and 'oil' in the same sentence.
Even Lord Browne (ex BP) was in public denial about peak oil.
But more than all the explanations by David and others, peak oil is what's driving oil prices skywards and will continue to do so, even if there are periods of price reduction when demand reduces due to slower economic growth.
'Easy oil' is soon to peak and then it's downhill all the way...
Christopher Millbank, London, UK
Structurally we are going to need an energy policy which limits dependency on oil... nuclear? perhaps...
In the meanwhile, just about anything can happen to oil price... down to $20? up to $100? ... any guess is welcome because they can all be right or be wrong...
if Iraq started pumping and Opec lost price control the marginal oil producer cost would be less than $20/bbl.
If Nigeria shuts down and Iraq keeps stand still, the price can go to $100/bbl
Michele, Richmond,
The PNAC "rule or ruin" plan is doing nobody good.
What amazes is that there is so little resistence.
But then that was how observers must have felt at other times. I am sure that you can think of some example of similar cowardice.
Buck Burris, Peoria, IL
A lot of it is greed.
$70 a barrel doesn't get £4.50 a gallon!
Brough, Forfar,
The price of oil increase is based on the price being in Dollars.
The petrol station prices go up accordingly, has anyone realised that petrol prices should have come down giving the exchange rate of the Dollar to the Pound
Jim Campbell, Aberdeen,
well at present we are 60-70
but in the near term the bias and risk is prices can fall to 40
Who benefits and keeps prices high , range from Russian to Arabian to American interests . Whilst Hedge Funds and others accumulate and stock pile , it is only a matter of timing ! and patience !
Why should Joe Public pay for the excess lifestyle of Russian Oligarchs Arab Oil Excess like the nonsesne expansion and speculation going on in Dubai and its neghbours ! Not until other cartels and forget Opec , are forced to let go! and this will only happen when those are ready to benefit from the new carnage that willbe created or new oportunities from lower prices! presently it is the other way , but time is running out !
David, Monte Carlo, Monaco
Forget about low oil prices. Cheap oil is history. A billion Chinese want to drive cars, go on holiday, and consume electricity just like we do. Crude (especially high quality crude) is increasingly in the hands of Opec as other supplies (N.Sea, US, etc) dwindle. Even refining is moving Eastwards as US, Europe, etc. have no or very limited plans to increase capacity. 'High' prices have so far had no effect on US consumption (witness current gasoline squeeze). Much higher prices are needed to curb consumption, and trust me, they will come.
a bernard, quimper, france
Let us face the facts: oil has been too cheap for too long. It is, afer all is said, a declining and non-renewable natural resource. In most Western-style economies the 'high' price of petrol is owing to the tax imposed on it by governments. Plastics, for example, have not increased dramatically. I am sure citizens in major oil producing countries are not unhappy with the so called high price of oil. The surprise in all this is the clear lack of foresight of the various commodity professionals and traders. Supply and demand rule in times of war or peace. What sort of arithmetic have they been using?
M Reid, Canberra, Australia
David,
You just don't get it do you? Oil is a finite resource. World population is growing at the size of the UK and Australia combined (80m people) per year. About 1 billion people in just 10 years.
ALL the major oil fields are in decline. Ghawar was discovered in 1948 with peak production in 1980. Nearly all production is being discovered offshore. The UK is now an importer. Didn't last us long did it? Most world exporters are in the same position and in decline. Many people are in denial, they cannot accept FACTS.
Saudi Aramco will never allow production to rise above 85 mbp/d again. The consumption of cheap petrol is being used at extraordinary rates in the Middle Eastern countries. They will need as much oil internally just to meet their own demands. Already we are see third world countries rationing electricity due to high crude prices.
We will see bidding wars, rationing and high prices beginning this summer. The west look out.
The lights are going OUT.
Paul Price, Warrington, England
So you are really saying that oil prices will stay high until they come down. Does that add much to the debate?
Peter, Dubai,
Roger Bootle is right, the MPC is simply pussy footing around. Interest rates need to rise tpo at least 6% to drive down inflation. Alan Greenspan (the greatest central banker in modern times) interviewed on 31st May 2007, said interest rates across the world are too low (http://www.msnbc.msn.com/id/18990919/). Interestingly he admitted blame for leaving interest rates too low between 2002 - 2003. He said he underestimated the resilence and flexibility of the US economy in 2002 - 2003. That low interest rate regime fuelled the US housing boom which bubble has now burst and when home owners are turfed out of their homes for defaulting on sub-prime loans they must resent the Fed Reserve for keeping interet rates low. The odd David Blanchflower on the MPC has since August 2006 (apart from one occasion) argued for interest rates to be lowered. So who's right i.e. Blanchflower or Greenspan who thinks global interest rates are too low. Go figure!
John Fernandez, London, UK
An excellent summary of the rationale for the level of crude oil prices.
I'm confident that the current level of US$ 50-60 is the basis for future planning with blue sky of US$ 70-80.
Many thanks for your paper.
JG Brown, Karaka, New Zealand