Where Now for Oil Commodity Prices?
Almost every day the news announces a further increase in oil commodity prices on the world markets, and we begin to wonder if there is an end in sight to these price surges.
Crude oil is a crucial driver of the world economy and is the most actively traded commodity in the world.
When the price of oil is mentioned on the news it usually refers to one of the two main global benchmarks, namely West Texas Intermediate (WTI) or Brent Crude.
But is crude oil expensive today? Remember by May it had risen by 40% since the start of 2008.
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But look at the price in real (inflation-adjusted )terms. What does this tell us?
Remember there was a price shock in 1980 during the Iran-Iraq war, when the price in real terms was $102. Using the US Producer Price Index suggests the previous early 1980’s high would be around $95 in April 2008 prices.
According to research by Deutsche Bank, spending on crude oil amounted to 5.9% of global output in 1980, compared to 3.5% today.
If, however, crude oil prices reach $150 per barrel then it will in effect consume the same proportion of world GDP as in 1980.
And just to put these price surges in perspective, Goldman Sachs has projected that crude oil prices will touch $200 by the end of the year.
Why are crude prices moving ahead so strongly?
It is sobering to note that while food commodity prices have risen over 98% since 1999, according to the US Department of Agriculture, oil prices have risen by almost 550% over the same period. Such increases will inevitably have a significant impact on global economic growth as the higher input costs of raw materials eventually work their way through to affect company profits.
A combination of two factors is principally responsible for the strong growth in prices. Firstly, global production of oil has been around the 86 million barrels per day level since 2005. In Russia oil output is declining, while estimates suggest Nigeria will see a 30% decline in production by 2015.
Meanwhile, Saudi Arabia which accounts for around 22% of total proven reserves, is not expanding its capacity to meet this surge in global demand.
Combined with this is the strong growth in demand particularly from the emerging ecomomies, led by China and India.
These nations are growing at a rapid rate and their infrastructure developments requires increased oil consumption.
Add to this the declining oilfield production in the UK and continuing instability in Iraq, which now has probably the world’s largest untapped oilfields, then it is seems likely that oil prices could hit the $200 prediction of Goldman Sachs.
In fact, Iraq is probably the only country where output could conceivably be increased significantly, assuming a more stable environment.
Why are price rises having less dramatic effect than in the 1970’s and 1980’s?
The rise in the crude oil price has been steady over the last 6 years or so, rather than a sudden spike as in the 70’s and 80’s.
For this reason the global economy can adjust gradually to the new price levels.
The increase in oil commodity prices is caused not by a fall in supply but by very strong demand from countries like China, and this will keep crude oil prices high unless these emerging economies go into a recession.
What about the future?
Given that most of the easy oil has been discovered and is accounted for in the mainstream proven reserve figures, there is growing credence given to the concept referred to as “Peak Oil”. And this view is held by a growing number in the oil industry and is given added weight when, for example, the Paris-based International Energy Agency (IEA) states that it may have overestimated future capacity.
When asked about how prices can be lowered, OPEC Secretary General Abdullah al-Badri said that there is nothing that can be done because of the way the oil futures market operates.
Perhaps the only way to stabilise the surge in crude oil commodity prices is to address the supply problem by reinvesting oil revenues into expanding production, refining and pipeline facilities.
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