EVEN if you do not track hourly movements on the International Petroleum Exchange in London, or the New York Mercantile Exchange (Nymex), the latest rise in oil prices has been hard to miss.
Forecourt prices for petrol and diesel have been edging ever closer and in some cases beyond the £1-a-litre mark, as anybody out over the Easter break, Britain’s own mini-driving season, will have noticed.
The real driving season, which kicks off in America on Memorial Day (May 29) weekend, and lasts until Labor Day on September 4, is only weeks away. That is when Americans take to the roads in even larger numbers than usual. And it is approaching at a time when oil has risen to record levels.
Last time it took Hurricane Katrina’s devastation of New Orleans and surrounding areas, to give us a record crude price of $70.85 a barrel. This time Iran’s nuclear programme, and the fear of American military strikes, have pushed US crude above $75 and North Sea Brent crude above $74. This might be a useful time, then, to revisit my prediction that oil prices are unsustainable at these levels and will fall, in due course, to $40 a barrel.
Let me start with the basics. Are high oil prices being pushed up by runaway demand from China and India? Is the strength of the world economy in general pushing oil demand up at such a rate that it is ignoring the rise in prices? The global economy, according to the International Monetary Fund’s twice-yearly world economic outlook, published last week, has “never had it so good”. This is the fourth year in which global growth will top 4%, with this year’s expansion set to hit a blistering 4.9%.
The IMF thinks the current oil-price shock has worsened global imbalances, directly and indirectly adding to America’s current-account deficit, and that it may prove more enduring than its predecessors. But it also notes that the economic impact has so far been modest, while adding the caveat that we may not be out of the woods yet.
In the context of the strength of the global economy, the surprise is that oil demand is not stronger. In many ways we are still paying the price, literally, for a sharp rise in world oil demand two years ago. In 2004 it jumped 4% to 82.5m barrels a day, according to the April oil-market report from the International Energy Agency (IEA). There was indeed a big increase in Chinese demand that year, more than 15%, as there was in America. But since then oil-demand growth has slowed. Last year it rose 1.3%, and only 0.3% in the advanced economies of the OECD (Organisation for Economic Co-operation and Development).
This year demand may increase a little faster — the IEA predicts 1.8% growth, other forecasters slightly less — but this is still subdued in the context of a booming world economy. So what’s the problem? There are, contrary to the impression one often gets, extra oil supplies coming through. Last year oil production averaged 84.1m barrels a day, 1m barrels up on 2004, and up strongly on its levels of 79.7m in 2003 and 76.9m in 2002.
In the past three to four years supplies from Opec (the Organisation of Petroleum Exporting Countries) have risen by about 4.5m barrels a day to about 30m — Opec also produces more than 4m barrels a day of liquefied natural gas — while non-Opec output has risen by 2m barrels a day. Supply, so far at least, has risen to meet the extra demand.
So why the spike in prices? One reason is actual supply disruptions. Action by militants in Nigeria has knocked out a fifth of the country’s production. The US-led invasion of Iraq, directly and indirectly, has imposed a huge cost for oil consumers in terms of higher oil prices. Iraq’s production, now 1.9m barrels a day, is 30% down on its pre-war levels, and the war has escalated Middle East tensions. Claude Mandil, head of the IEA, last week also cited political uncertainty in Venezuela, Russia and Chad.
Add to this the future uncertainty over Iran, and whether George Bush’s last act as president will be to bomb the country’s embryonic nuclear industry out of existence, and you have a recipe for uncertainty that could last for years.
That is not the only factor pushing up prices. Lee Raymond, the recently retired chairman of Exxon Mobil, received $686m in pay and perks between 1993 and 2005 and retired with a pension and stock options worth, on some estimates, $400m. He has become, to critics, the ultimate oil-industry fat cat.
He is also uncompromising, saying in a Columbia University lecture last week that oil will not be supplanted by other fuels for the foreseeable future and predicting that neither Exxon nor its rivals will be building new refinery capacity in America because the risks would be “extraordinarily high”.
This lack of investment in refinery capacity, in America and elsewhere, is helping to drive prices higher — both because a shortage of capacity has the effect of restoring refining margins but, more important, because it feeds back to a higher oil price. Big users of oil products, such as airlines, hedge by buying crude oil futures, which helps to drive the price higher, and keep it there.
So what’s the outlook? In the short term anything is possible. A bit more tension on Iran and a couple of nasty hurricanes and $80, $100 or $120 a barrel could result. But the history of oil is that the bigger the upward spike, the sharper the subsequent fall. That is what gave us ultra-low prices, $10 oil, after big rises in both the 1980s and 1990s.
The current boom in the world economy will fade, leading to a fall in global oil demand. There will be more supply, stimulated by current high prices. Dr Leo Drollas, chief economist at the Centre for Global Energy Studies, argues that through the current mess and confusion the fundamentals have not gone away, and they point to oil being too high at these levels.
I agree. I haven’t given up on $40 oil. It is just taking a bit longer to get back there.
PS: My observations last week on the high inflation rate for haircuts produced offers of free coiffures, the kind of perk that rarely comes my way. There was also some criticism of my neglect of rising council-tax bills in listing the increases squeezing household finances.
While haircuts are rising, plenty of things are still falling, which set me musing about the best-value product you can buy these days. My vote would go to the humble bicycle. You get a lot of steel, rubber and technology for your money, and prices start at about the cost of a tankful of petrol for a large car. Readers may have other ideas.
Meanwhile, the rise in inflation expectations was confirmed by the Bank of England’s quarterly attitudes survey last week. People think inflation has been running at 2.8% and expect it to be 2.7% over the next 12 months, compared with the official 2% target. Last week’s astonishingly good figures showed inflation running at just 1.8%, and 2.1% on the old RPIX measure (Retail Prices Index excluding mortgage-interest payments).
The minutes of the April monetary policy committee (MPC) meeting showed a 7-1 vote in favour of keeping base rate at 4.5%. Steve Nickell was the lone dove, and is likely to end his MPC career next month in similar vein. He thinks the labour market is telling us inflationary pressures are likely to weaken further.
Peugeot’s announcement of the closure of its Ryton plant in Coventry was a reminder, after a year in which the claimant count has been rising, that all is not well. Nickell may yet get his wish, though not until after he has left the MPC.
