What is fuelling oil prices? By Baljeet Grewal The Start Online | February 6, 2006 http://biz.thestar.com.my/news/story.asp? file=/2006/2/6/business/13246373&sec=business
The core to understanding oil price fundamentals lies in three broad areas: the primary demand-supply balance, hedge funds/speculative positions driving prices, and the wild card of geopolitical disruptions THE relentless rise in oil prices of late and the potential drag that costlier oil could have on global economic growth have become a pressing issue. The potent mixture of robust demand, limited spare capacity and multiple threats to supply that are now driving the market is the precursor to a world supply-demand imbalance. Assuming investors were told in 2001 when economic momentum was bottoming out that the price of oil would more than triple in five years, they would probably have predicted a world economic meltdown of epic proportions. Crude oil prices hit a new high of US$68 per barrel two weeks ago a similar scale of price peaks in 1973/74, 1979/80 and 1989/90, all of which were followed by global recession and rising inflationary pressure. Today, however, global GDP growth is well above market dynamics, while inflation remains relatively low. Why has the world economy fared so well this time? Economic analysis will reveal the following: l The pace at which oil prices has risen has been gradual far unlike the drastic "oil-shock" periods of the 70s and 80s which saw oil prices triple in a span of five months. This paced increase has allowed consumers and businesses time to adjust, and hence the marginal disruption to confidence and economic activity Global cost of production is still lower than the price of oil when adjusted for price inflation. Hence, in real terms, oil prices are within manageable levels ·The "oil-shocks" in the past were triggered by supply disruptions in the form of Organisation of Petroleum Exporting Countries (Opec) embargoes, Iran revolution, Iraq invading Kuwait, etc. This time around, although there remain persistent supply threats in the form of Russia's pipeline, Iran's impeding nuclear programme, etc, the rise in oil prices is predominantly driven by increasing demand The core to understanding oil price fundamentals lies in three broad areas: the primary demand-supply balance, hedge funds/speculative positions driving prices, and the wild card of geopolitical disruptions. The market today is more focused on event risk, and any small disruption in production, due to the thinness of refinery capacity, hurricanes included, could lead to a short-term hiccup. Global oil demand has increased from 70 million barrels per day (bpd) to above 82 million bpd in the past 10 years. Equally, the American oil addiction is a genuine problem. While inefficient oil consumption in China and India remains vast, they only account for 15% of total world output. The US accounts for 25% of total global oil demand, guzzling at an insatiable pace far outstripping emerging countries. China's oil imports have moderated so far this year, taking a stance not to accumulate reserves when oil prices are high. Also, the move to employ more efficient use of oil in China and India is likely to see sustained demand without "energy shocks". The concern is more with the supply of oil world oil supply has more or less halved in the last decade largely due to political risks and old and over-exploited mega-fields that are becoming less productive. Nevertheless, new sources of oil producing countries (non-Opec) have also emerged as important players, namely Russia (producing 11% of world oil output), Mexico, the African region, etc. Higher prices may also herald substantially higher investments to enhance efficiency and thus long-term supply. In the interim period, there is no risk of running out of oil, but the chances of being able to match the estimated growth in demand over the medium term with a rise in production is being seriously questioned, and increasingly factored into the oil price conundrum. The impact of speculation/political risks on oil prices is far more challenging to determine. An estimated 30% to 35% of oil prices currently are estimated to be speculative in nature, and suffice to say, it is largely oil hedge funds which are shoring up prices at present. However, speculative positions don't last long, and it is expected that when the global and US real estate boom bottoms out towards the third quarter of 2006, hedge funds will exit the oil market, which will see prices stabilise themselves. High oil prices tend to have a broad-based impact on local economies, specifically, weakening demand for trade goods by countries heavily reliant on oil, namely the US, Japan, and EU. If the rise in oil prices prolongs, producers will pass on higher costs to consumers, thus making imported goods more expensive. Oil prices at record highs could also impose inflationary pressures on the local economy. In Malaysia's instance, aside from the negative impact on transportation and aviation sectors, the economy is expected to remain steadfast, given that Malaysia is a net oil exporter and high oil prices translate into stronger government budgetary positions. What remains crucial for Malaysia is the re-investment of petro- dollars back into productive areas of the economy so that the oil boon filters through various sectors and translates into better earnings. The price of oil is expected to come off its high to continue trading at an average of US$60 per barrel. Rising oil costs are not necessarily bad news for all parts of the economy. Higher prices will encourage increased investment in the industry. Sustained high oil prices may also help, in the long run, to reduce dependency on crude oil. Nevertheless, in the long term, the crucial issues of demand-supply, speculative positions and geopolitical risks will have to be weighed to ensure more sustainable use of oil as a commodity. Meantime, we may have to live with more expensive energy and keep a wary eye out for economic side effects. The author is the chief economist and head of research at Aseambankers Malaysia Bhd, the investment banking arm of Malayan Banking Bhd. Aseambankers possesses a notable research initiative with the primary task of undertaking comprehensive research in the area of Malaysia's capital markets. The information herein has been obtained from sources believed to be reliable but cannot be guaranteed. The views or opinions expressed are subject to change at any time. Neither the information nor any opinion expressed is to be construed as a solicitation for the purchase or sale of any securities. Aseambankers does not assume any responsibility whatsoever in this respect. «¤»¥«¤»§«¤»¥«¤»§«¤»¥«¤»§«¤»¥«¤»§«¤»¥«¤»§«¤»¥««¤»¥«¤»§«¤» This is ZESTEconomics. Post economics-related articles and event info to [email protected] If you got this mail as a forward, subscribe to ZESTEconomics by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! 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