29 July 2007
Oil: $100 a Barrel — or $200?
By Gwynne Dyer
Nine of the last ten serious downturns in the world economy followed a spike in the price of oil, and we are heading for another spike, with oil back up near the peak of $78..40 a gallon that it reached almost exactly a year ago. A record number of options contracts are now being sold that entitle customers to buy oil in the future at $100 a barrel. That tells you where the inside players think the price of oil is heading, since those options will only be of value if the price were actually above $100 a barrel.
That is the price that Goldman Sachs, the world’s biggest brokerage house, predicted oil would reach by 2009. However, one big negative headline — further disruption of supplies from Nigeria or Iraq, say — and oil could be trading at over $100 a barrel by next month. But the concern is not really about oil prices. It’s about what more expensive oil will do to the world economy, and the professional optimists are still optimistic.
The spike at $78.40 in July, 2006 didn’t cause a recession, so why should this one? Indeed, why would even $100 a barrel cause a global economic crisis, given that one hundred US dollars today is only worth about the same in most other currencies as $78.40 was a year ago?
Oil sales are almost all denominated in US dollars, which are worth almost a third less in euros, pounds or yen than they were two years ago, so the countries of the Organisation of Petroleum Exporting Countries (OPEC), are not rolling in sudden wealth. The oil exporters spend most of their income in other currencies, so from their point of view the recent surge in the oil price only restores the purchasing power that they lost over the past two years due to the US dollar’s slide.
More importantly, most of the big importers of oil in the industrialised world are not really paying much more for oil than they were two years ago. The rising dollar price has been largely cancelled out by the fall in the value of the dollar, so it’s not really busting their budgets.
American consumers are feeling victimised, but they get little sympathy in the Middle Eastern countries that dominate OPEC, as most of these governments believe that President Bush’s invasion of Iraq has made their neighbourhood a far more dangerous place. OPEC is not going to pump more oil out of gratitude for Mr Bush’s policies.
As for the steep fall in the value of the US dollar, that’s what happens to your currency when you try to fight an expensive foreign war without raising taxes at home (as Richard Nixon found out over Vietnam in 1971.) Seventy-six dollars a barrel will not cause world economic growth to stall — and even $100 a barrel might not do so. But will it stop there?
What is really significant about the current surge in the price of oil is that it has NOT been driven by some apparently apocalyptic crisis like the Arab-Israeli war of 1973 or the Iranian revolution. (Neither event was actually all that apocalyptic, in retrospect, but the markets don’t do long-term perspective.) We have got three-quarters of the way to $100 a barrel without a crisis, driven simply by stagnant production and soaring demand in the big Asian economies. We could get the rest of the way on a rumour, and the price rise would not necessarily stop there.
The truly significant change in the situation is the stagnation of supply, not the rise in demand. New oil-fields are much smaller than discoveries in the previous generation (the last really big oil domain to be developed was the North Sea in the 1970s), and they tend to be in much more remote places.
The number of new deep-sea drilling rigs now under construction is almost equal to the total number that currently exist in the world (seventy). When you have to look for new oil at depths of over 1,500 metres (5,000 ft.) under the sea, or coax it out of the tar-sands of northern Alberta by equally expensive techniques, the era of plentiful cheap oil is definitely over.
OPEC is squeezing supply a bit to keep the price high, but its members are pumping close to capacity and only Saudi Arabia is putting in major new production capability. Non-OPEC oil output is predicted to stay flat for the next five years. It may not really be “peak oil” yet, but at the least we are seeing a lot of phenomena that mimic that time.
If the American mortgage crisis does not tumble the global economy into a recession, Asian demand will go on growing until the oil price does it. At $100 a barrel if we’re lucky — or via a detour through $200 a barrel if Dick Cheney decides to attack Iran.
To shorten to 725 words, omit paragraphs 2 and 7. (“That is…optimistic”;and “As for…there.”)