Who is Making the Oil Fume ?

As the oil fumes and the world simmers in the bubbling heat, experts from at least 35 countries, 25 oil company CEO’s and 7 global energy organizations assemble at Red sea city of Jeddah today in a bid to explore ways to cool things down. The soaring oil prices spell economic downturn and danger that may swirl the globe towards an enormous disaster.

As if to underscore the Goldman Sachs predictions, or to rather prove them as conservative, that the oil could rise to $150 a barrel by 2010 & $200 a barrel by 2012, we have already seen the oil surge to a new level of a whisker below $ 140 last week. The possibility of $ 200 a barrel oil was also confirmed by Iranian Oil Minister Ghulam Hossein Nozari in an interview with the official INRA news agency in Tehran last month when he stated

“ If conditions continue, reaching a period when oil is supplied at $200 a barrel is not out of reach.�

What is actually causing such an unprecedented price upsurge is a big unsettling debate and amongst the many factors that are being pinned down, enhanced global demand, speculative buying, production and refining capacity restrictions and geo-political situation are getting the most of the blame.

Only a decade ago, when the Asian financial crisis hit the East Asian economies, the crude prices sank close to $10 a barrel. However, in the threatening circumstances of today when the IMF and WB have revised their estimates of the world economic growth for 2008 & 2009, we are yet to see any respite.

US remains the largest oil consumer in the world. Economic observers and analysts are of the view that it is no longer a question whether there would be a recession. The question is how long and how painful? Increasing joblessness, soaring energy and food prices, falling home values and the continuing credit crunch mar the US economy in particular and global economy in general.

Many single out global demand as the biggest factor causing the dilemma. They argue that the demand remains strong despite the rising oil prices. While the economic growth of the US has slowed down it is not accompanied by a corresponding decrease in the demand of oil. The probable factor is the lower fuel prices and tax component that make it more affordable for the consumers in US. Since these prices in Europe are more than twice the prices of fuel in US, they constitute considerably lesser proportion of the expenditure for an average US household.

Whereas the GDP growth rate is tipped to remain anywhere between 0.5 – 1.5% in the US, EU and Japan during the next two years, it is likely to come down marginally to 9% from 11% in China and 8% from 9% in India. The demand of oil is, therefore, expected to remain strong in the two fastest and most populous growing economies of the world.

China is reportedly experiencing an unprecedented automobile boom at present. Its car pool has risen by hundred fold from half a million cars to more than 50 million since 1978. While fuel-efficient and hybrid cars are a reality for the Chinese market, the fact remains that it is the second largest market of the oil in the world today. Over the last decade, the oil demand in China doubled to 7.4 mbd per day in 2007. It now consumes 40% more oil than Japan does and the projected demand of the market stands at 8.6 mbd in 2010 and 9 mbd in 2013. At the same time, China is the fifth largest oil producer in the world but its huge domestic demand has seen the country go from self-sufficiency to importing half its requirement of oil in only 15 years. This dependence on foreign oil is likely to grow further in the future.

As a result of its robust GDP growth rate, the demand of oil grows in India as well. Tata has launched its $2,500 Nano People’s car as an economical customer solution while its success and popularity would in turn spark increased fuel consumption.

Last but not the least, the oil producing countries face internal pressures as their populations increase as a direct result of high birth rates and substantial immigration. This is particularly true for Middle Eastern countries. Demand for air conditioning and desalinated water are on the rise that consume a lot of energy. The diversification of the economy has also improved the standard of living and caused the automobile pool to grow. As a result, the demand for oil in the Gulf countries increases at 4-5% annually currently as against 2% in 1990s.

It is not out of context to mention that according to experts, trillions of barrels of oil reserves are laying unutilized underground that cannot be recovered owing to a multitude of reasons such as geo-political situation, prohibitive cost of recovering the oil, lack of skill, training and equipment and lack of refining facilities.

The ongoing threats and attacks on Shell and Chevron installations in Nigeria are making the matters worse.

Those hailing from the above school of thought criticize OPEC for not surrendering to the demand of increase in production just to keep its revenues high. However, those on the other side of the divide on the issue have their own counter arguments to make.

According to these sources, increase in global demand is understandable but there is nothing phenomenal that can explain doubling the price of oil from around $60 to $70 in one year and a rise to nearly $140 mark from $100 since the start of the current year.

An unprecedented day of volatile trading that saw US crude go up by $11 per barrel on June 6th lend weight to the assertions about the role of speculators in exploiting the market. In addition, the high intensity of taxes on global fuel prices is also termed as one of the biggest contributing factor towards the current turmoil.

Another perspective is that dollar has grown weaker against Euro and Yen. Thus the oil has not gained as much as perceived in the absolute terms. Speaking in terms of the dollar make the things look bleak. However, there is some sort of obvious co-relation between the dollar and oil prices. Whenever the dollar gains value, oil prices slide only to creep up in the reverse case.

Nevertheless there has been a rapid price surge and big investment inflows in the financial markets. According to Deutsche Bank estimates if oil were to reach $150 a barrel, it would bring the market capitalization of oil and gas equity in the S&P 500 US stock market index to more than 25%, exceeding the valuation of technology stocks at the peak of the Dotcom bubble. There is a talk of an “oil bubble� going on in the market at the same time. According to Michael Waldron, oil analyst at Lehman Brothers:

“ The obvious parallel in our mind is we think oil is overvalued where it is priced based on the underlying fundamentals, which is parallel to the Dotcom boom and bust.�

The Nasdaq stock market index saw most of the Dotcom fad by hitting a peak of more than 5000 in March 2000 and then sinking to half the value by the end of the same year. Some predict a similar fate for oil.

According to a former Indian oil minister official now at the International Institute of Strategic Studies in London “If there is a genuine downtrend in industrial growth, there is going to be a fall. If that happens then you can expect a fall as sharp as the rise has been, maybe even sharper�.

Politicians in US and Europe are putting the blame upon the speculators for the price hike. Hedge funds, investment banks and pension funds looking for portfolio diversification and moving into oil and commodities are being termed as speculators in the blame game. A possibility of regulatory curbs on these “speculators� is being looked into in the crude oil futures market.

On the contrary, Barclays Capital has estimated investment flows into commodities totaled about $225 billion at the end of first quarter this year. But it did not believe that there was a price bubble and it further said in a note

“Nor do we see the involvement of institutional investors as being a cause of price rises�

Bringing out the disparity Evan Smith from US Global Investors Inc. maintained

“Oil is a physical commodity with a finite amount while Internet stocks had an unlimited supply that was created out of thin air�

In a surprise late move, Beijing has increased the fuel prices by 17 – 18%. While there wasn’t any pressing need with Chinese economy in good shape unlike many others, the initiative is being widely seen as a gesture of goodwill towards the global community in general and US and Saudi Arabia in particular. The increase in prices would cause the oil demand in China to slow down that constitutes a substantial proportion of the global demand.

On the other hand while most OPEC countries such as Iran , Venezuela and Libya remain stern and blunt about any possible increase in the supplies, Saudi Arabia sent some signals that it might ultimately be ready to increase its output.

While the global experts and leadership lock horns in Jeddah today, let’s see if they can determine the way forward employing all the global synergies as the world faces one of the most unprecedented global dilemma and crisis in the history. Else are we going to see a big improbable change? As a rather disappointing voice was heard form the platform of Al Shall Economic Consultants of Kuwait when complaining about the attitude of the suppliers they said

“ Perhaps we are on the verge of a new era in which oil could lose its importance, exactly as coal did 100 years ago�