Saturday, July 15, 2006

What's pushing oil prices higher?

The Iraq war has certainly been a factor in the run-up in oil prices, but there are others on the list that are probably more critical. Here’s why:Oil production in Iraq is still below pre-war levels, but it's gradually improving. Just before the U.S. invasion Iraqi production was about 2.6 million barrels per day. Today it's about 1.9 million, about 25 percent lower.But there are other, more pressing, forces pushing oil prices higher. In no particular order, here are some big ones.

Supply cutoff. The recent flare-up of tension following Israel’s attack on Lebanon has increased the risk that other Middle East countries could get drawn into a widening war. Iran has made it clear it is prepared to use oil as a weapon by cutting off exports — just as it did after the Iranian revolution in 1979 overthrew the U.S.-friendly Shah Pahlavi. With Iranian exports of nearly 3 million barrels per day, another suddenly cutoff would almost certainly produce another big price spike.

Growing demand. High oil prices are supposed to cut demand as consumers find ways to do more with less. That’s what happened in the 1970s, when U.S. oil consumption actually fell after a spike in prices spurred conservation and development of more efficient cars and appliances, for example. But this time around global demand, at 85 million barrels a day (roughly a thousand barrels a second), is still climbing.

No spare capacity. Even during the oil shocks of the '70s, there was enough global production capacity to keep up with demand — once OPEC decided to put it on the market. That’s no longer true. With the exception of Saudi Arabia, OPEC producers are pumping as fast as they can. And given the notorious uncertainty about the cartel’s production data, it’s not at all clear that output will grow fast enough to meet demand.

Investment slowdown. Though oil producers are awash in cash, not enough of that money is flowing to regions where there are known oil reserves. Iraq’s oil infrastructure — on a good day — is still some 30 years old and badly in need of an upgrade. Venezuela and Nigeria could also very likely expand production capacity, but political turmoil has discouraged investment in those countries.

Weak dollar. This has an indirect impact, but since oil is priced in dollars, as the value of the dollar falls, the price of oil in dollars goes up. Over the last five years, the dollar has fallen by 33 percent against the euro. If that keeps up, the upward pressure on oil prices will remain.

Weather. The odds are against a repeat of last year’s devastating hurricanes in the Gulf of Mexico, which knocked out the equivalent 30 percent of Gulf oil production from last September through June. (More than 10 percent is still shut down.) But with memories fresh of what Mother Nature can do, oil traders will remain jittery until the hurricane season is over.

Investor demand. Oil prices also are being stoked by investors in the futures market who have no intention of ever taking delivery of a barrel of crude. The rapid run-up in prices over the past two years has drawn billions of dollars worth of bets that prices will move higher. If the other forces driving prices higher persist, expect investors to continue bidding up futures contracts. The flip side is that with all this extra capital sloshing around the oil markets, a pullback in prices could be amplified as speculators bail out.


Dinesh C Nagpal said...

Impact, Analysis & views on:
Surge in Crude Oil Prices.
View on Oil Prices;
Stocks of Crude Oil in the world are normal or better than normal. Still prices are rising due to
1. Growing consumption in emerging markets like China and India.
2. Geo political tensions
3. Non Traditional money for e.g. hedge funds moving into crude oil markets for short term gains.
4. Estimates around the world says the upwards target is around $100 p/barrel
There is an element of speculation in Crude Oil, investors tend to take too optimistic
views over estimating growth of energy demand . As in in other asset classes where money is withdrawn by investors similarly in Crude oil too the hedge funds monies can be withdrawn at the slightest opportunity of better returns in any other asset
At present as well as in the long term we have enough reserves of Crude Oil in the world. The World Crude Oil Reserves have risen to 1.3 trillion barrels, more than
double in last twenty years. Twenty years from now the the reserves are estimated
to be 2.96 trillion. Actual numbers have always outperformed estimates. That translates in approx 5% production growth each year against expected demand
growth of 2% every year.
In the very short term, however the concern is of production/distribution. Short
term factors affecting the distribution would be Middle east tensions and violence in Nigeria. Last year the hurricanes in US and Mexico halted the Oil production for sometime. This year these capacities are likely to become normal and add to existing
capacities. Least to say that in case of Middle east tensions, US would spare no efforts to get back Iraq’s production to its full capacity, which alone can cater to 40% of world needs.
During stable periods on the energy scene, prices have declined by around three percent per annum. OPEC has then been asking it members to reduce production to
keep prices steady.
The retails petroleum prices in China have been rising in line with rising global oil prices. As immediate measure the Chinese Government is likely to further raise interest rates to contain growth and inflation. This could slowdown the demand for oil there.
The world is also tapping other enormous resources such as an natural gas. The Artic region is a potential oil resource which would be tapped sooner than later. New
technologies that have not been exploited for economic or other reasons will suddenly become vogue and solutions will emerge that create new opportunities for
The question is not so much of resources but when those resources will come on stream and at what rate.
In simple works, we can say that while the tanks is full, the problem lies in the tap.
It is highly unlikely that these situations of high prices will carry on for lengthy periods.
As for India, taxes and levies account for over 50% of the retail prices in petroleum products. With the coalition UPA government in power the pressure would be on the
government to bear the increasing burden.
As such the burden on Indian corporate on account of global price rise is expected to
be minimal.

Sharad C. Kapadia said...

I wonder why with so much oil and gas discovery in India, esp. southern oil fields by almost all stake holders, there is slackness or lack of visible actity from them to establish gas pipe lines, to increase the refining capacity of existing and estabilshment of new facilities in India!!!

Or is it due to the temptation to pocket front end money from the foreign suppliers by vested interests in and out of government?

Any investigative journalism in this regards may unearth shocking facts.Or can throw light on the red tapism in sanctioning permissions.

At the rate oil prices are moving up, even import of machinery by air cargo can be more economical than spending valuable scarce forex in regularly importing oil in the country.

Sharad C. Kapadia
SuratJu;16, 2006

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