The underlying factors of oil price rise

Posted in Energy Security , Other | 26-Nov-07 | Author: Ioannis Michaletos

High gas prices are posted at a Union 76 gas station in Beverly Hills, Calif., Wednesday, Nov. 14, 2007.

The dramatic increase of oil prices over the past few months, that saw the index rising as much as 99,29 USD Cents a few days ago, is influenced heavily by the international capital that seeks to enjoy higher profits by exploiting the so-called Hedge Funds and invest heavily into oil futures that predict rise in the prices. That and a number of other important reasons predict a probable higher energy price index over the coming months of the winter.

The devaluation of the Dollar that is almost 50% less-valued than the Euro is a first explanatory factor. Oil is priced in USD in the world markets and its value decrease has enabled the transfer of capital from currencies such as the Euro or Sterling Pound to USD in order to invest in oil futures and options. Moreover as long as the Dollar looses its value there is going to be a steady increase of the price of oil, therefore creating a sort of a vicious circle. To the aforementioned one should also include the subprime crisis that inflicted the investment houses and banks worldwide and saw the transfer of further funds from the ailing real estate sector to the oil one in the form of contracts predict rise of the commodity.

Another aspect of the whole increase in price could be explained by the inability of OPEC to operate as a sole energy cartel in the planet. Even though it currently controls some 40% of the overall global oil production, only Saudi Arabia, its primal member has the ability of increasing production in a short notice, thus being able to exercise downward pressure to the markets. Further, the introduction in the past few years of all the major investment brokers into the oil trade in the form of futures and options lowers OPEC ability to manipulate prices as it was able to do relatively easily since the early 70’s. In short oil has become a truly global investment proposal and for the time being competition has as a paradox effect, the increase of the price, albeit that could be reversed if other factors change as well. It will not be improbable as to predict that oil prices could plummet if investors start predicts a decrease in prices and in parallel the oil producing states manage to enlarge their production.

Another element to notice is the various geopolitical ambivalences and conflicts that hinder political stability in a large segment of Eurasia. Iraq, Iran, Israeli-Palestinian conflict, Turkish-Kurdish skirmishes, are all concentrated in the center of gravity of the world oil trade, namely the Middle East. In addition the ambiguity over the intentions of Hugo Chavez in Venezuela and President Putin in Russia, are some other parameters in the whole equation. Finally Nigeria is in a state of a civil war in the areas rich in oil and where most of it’s underneath richness is to be found. All of the above countries have actually the bulk of resources in the planet and until the world order is not normalized at least psychologically; the markets will behave in an upward trend.

Iraq by itself is a major issue, since the production of the country is not sufficient enough to assure a steady flow to the markets, as it was the case before the 2003 war. For the moment there are not signs of any positive development in that field and it should be noted that Iraq was at time the second largest oil producer in OPEC and its severe decrease means significant rise in oil prices. Terrorism also –And not just in Iraq- is an X factor for oil prices. For instance the attack on the oil industry complex in Saudi Arabia by Al Qaeda in May 2004 witnessed a sudden spike on prices, despite the failure of the terrorist act. One should wonder of the consequences of a successful terrorist attack in an oil-producing country, a hypothesis regularly discussed by security analysts across the globe

Furthermore over the past generation there has been little investment in the refinery sector of the oil energy industry. Both USA and Russia have neglected to invest in their refinery industries, thus contributed in the overall scenery. There are also serious considerations around Russia’s ability to manage its energy know-how in order to invest in new oil fields as well, thus future plans relating to oil transfer and new pipelines might end up to be just pipedreams, whilst future seams bleak for the market that cannot wait for long-term investments.

Last but not least, the great demand for fuel by China and India most notably is a great factor. Since 2004 China is the number 2 country in the world in oil consumption and its accelerating growth of around +10% a year seems unstoppable. China being in essence a centrally command economy, a prime investment destination and the first in monetary reserves state in the world; is not worrying for a possible recession due to the rising oil prices and it should not be expected that its development will be stalled by a further increase. Moreover a large percentage of Beijing’s production is due to coal thus being able to finance its expansion even to the expense of environmental destruction by this energy efficient but ecological not-friendly fossil fuel. On overall oil is not a big issue for China.

The effects of oil price rise are already visible for middle-sized economies especially dependent on energy imports. Greece for example imported a value of 2.5% of its GDP in oil in 2003, whilst for the first 9 months of 2007 it spent an equivalent of 4%. Already GDP growth has lowered to 3.6% for the July-September period versus 4.6% the January-March one, according to statistics by the Greek Financial Ministry.

The oil increase most probably is set to boost further because the multitude of reasons affecting it are not about to change in the near future. It is fair to assume that a price of 120 USD would be possible during the coming winter term. On the other hand there are some sectors that will benefit considerably by this situation. The charter index prices for the oil tanker vessels will most certainly benefit since the buyers will be eager to obtain quantities of the commodities so as to forestall a further increase, a situation that rapidly becomes a spiral response by the markets. Also investments in gold and other precious metals is traditionally a method of securing assets in times of uncertainty. The real estate sector in the oil rich regions might also benefit, as well as, all assorted industries that function satellite to the main oil one, such as machinery, transportation and furthermore recruitment corporations specialized in energy specialized personnel, energy publications and so on.

The only certainty is that the global markets will never stop operating, and a recession is just an opportunity for a re-engineer of the existing modus opperandi of the economic system. Expect also a strong demand for renewable energy resources (Solar, wind, biofuels, nuclear), that if strongly implemented it will ignite the reverse development of a downward trend in oil prices. This might be indeed the future and the current state of affairs might finally prove that the era of oil is over, despite its mighty role as it is understood nowadays.