Business | Investment
Dialogue of the deaf on oil
Opec's response to high prices is in sharp contrast to what the market wants.
- By Dalton Garis, Special to Gulf News
- Published: 00:10 March 15, 2008
Opec is telling the markets, "There's plenty of oil." But the markets seem to be saying, "We don't think so," and are bidding the price for New York benchmark crude to $109.00 per barrel. Neither Opec nor the market seems to be hearing the other. What's going on?
Opec is concentrating on today's supply quantities and what is likely to be needed in the near term. They know, for instance, that the US economy is slowing down, and that it is the world's largest single consumer of oil. This could free up one or two million barrels per day. If Opec increases supplies, therefore, there might be a very quick fall in prices if consumers suddenly realise that there is more oil than needed.
Opec countries, which are gearing their economies to take advantage of the revenue streams from a doubling of oil prices in 12 months, doesn't want this to happen. So they favour supplying just enough oil rather than too much.
Markets, on the other hand, are concentrating on two things: (1) the unprecedented increase in oil demand by emerging econ-omies like China and India; and (2) the perceived lack of any tangible increase in the production capacity to bringi more crude to market.
Apprehension
That is why, even though today's markets are seemingly well supplied with crude, the price keeps going up, because the markets are wondering about tomorrow and worrying that "producers don't get it", and are not hustling nearly enough to increase production capacity.
They absolutely fear that China's demand is much greater than Opec and other producers imagine, and will cause prices to rise even more. They are naturally buying at $109.00 per barrel because this seems better than waiting while prices continue to rise.
And as a result, their very buying actions are pushing the price higher - just as they had feared, increasing even more the pressure on prices. So tomorrow's shortage fears are making today's oil price increase.
Are they right to worry? Actually, there will not be a shortage of oil, just a shortage of cheap oil. Oil will be available but not at the old prices. How could prices stay the same when demand keeps increasing faster than supply?
More consumers are prepared to buy and import oil and many exporters are now net importers. So surplus production capacity that could meet increasing demand or get us through an emergency is just not there as it once was. And this is feeding into current oil prices, changing the ordinary supply-demand analysis into a fear-and-greed analysis.
When the available excess production that can be offered to world markets falls below some critical value, oil market players change their style of analysis from quantities of production and consumption to the relative strengths of fear and greed.
Fundamental supply and demand analysis guides trading decisions when there is little worry of the world having sufficient oil to meet today's - and tomorrow's - expected and perceived needs. But if markets begin to think that current and expected production will not be enough to satisfy growing demand at today's prices, then those prices are bid up. This is a natural, but painful process.
And that critical value has apparently been reached. The surplus of world production over consumption is hitting new lows, so that were there to be a crisis in the Straits of Hormuz, an embargo by Venezuela against the US, another hurricane in the Gulf of Mexico, a broadening insurgency in the Niger Delta, there might indeed be shortages of oil in some markets at current price levels.
Thus, even though the world has not experienced any shortages in crude oil supplies - indeed, in the US stocks are at multi-year highs, the price keeps climbing.
Fundamentals
Markets seem not to be interested in the fundamentals of supply and demand, but have fastened their attention on the fear of a future shortage and the money that can be made selling into that fear.
The price of the Nymex West Texas Intermediate benchmark crude of $109.00 per barrel is now as high or higher than it ever was, even adjusting for inflation and the fall of the greenback's value against other currencies. And the local benchmark, the increasingly important DME Oman, traded on the Dubai Mercantile Exchange, is now $98.85 per barrel. This is the highest price for a heavy sour oil.
Markets for crude are barometers for future perceptions. With China consuming over seven million barrels per day and growing at an annualised rate of over 12 per cent, its economy, largely made up of heavy industry, will double in a mere seven years. And with crude having such long supply chains, any political crisis will continue to force prices upward.
- The author is associate professorof economics and petroleum market behaviour at the Petroleum Institute (ADNOC), Abu Dhabi.
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