May 2004 saw an upturn in oil prices in international markets. On Friday 21st May, West taxes for crude (WTI) touched a 21 years record high of $41.85.
The major consumers of oil, the seven rich western nations calls Opec, a representative body of 11 cartel members of oil producing nations that contribute 1/3 to the world oil, to increase the aggregate supply so as to push the prices down to some reasonable price. The consequent 'reasonableness' of price is itself in question.
The current high price, if adjusted for inflation, is still half of the prices of oil-price shock of 1970s. The severity of the problem is not that acute as it was in 1970's as western economies have substituted other energy sources and now, as a rough estimate, only half dependent on oil.
The Opec old price range of $22-$28, set in 2000, now seems redundant, on account of significant dollar depreciation and inflation since then and thus OPEC is affirmed to revise it.
There are multiple reasons behind the current price rise. On of the main reason that is guiding the market course is speculator's manipulations that are using the high demand prospects combined with threats to oil supply in their favour.
On the demand front, IEA forecast global demand growth of 1.95 million b/d, an annual growth of 2.5 per cent in global demand, a rate seen after 1988. The huge demand is coming from China, which needs fuel to feed its industrial growth.
In addition, low interest rate scenarios in the US, combined with high growth rates and summer vocations have also adds to the demand for oil in North America. The situations on the supply front are also not in the favour of consumers.
The oil supply from Iraq that was expected to resume at least 3 million b/d by now is still hovering around 2.4 million b/d owing to the serious resistance faced by US forces in Iraq both from Sunni and Shitte militants, which was beyond the expectations of the US army and those of energy forecasters.
In addition, oil producing and export facilities in the Gulf region are under serious threat to terrorist attack and Saudi Arabia has already faced such attacks to its oil facilities.
Coupled with increase in demand IEA has forecast a lower growth in the supply from 1.3 million b/d to 1.2 million b/d. What adds to this demand and supply situation, is the low levels of US inventories that allows sufficient scope to commodity brokers to play in the market of hedge fund and drive the market in their favour.
At present, US crude inventories stand at 16.5 million barrel, less than five-year average for the similar period of the year. Economists are concerned for the current rise because as a rule of thumb, every $5 increase in the price of crude leads to a quarter percentage reduction in global GDP.
Though at present average price for 2004 stands at $33, still not in red but if current trend continues, then world economy may be back to the reversionary period. Historically, each oil price hike is followed by a global recession.
In addition to economic concerns, current price rise has caused political tensions among the powerful states around the globe. The concerns of Bush and Blair administrations are that the elections are approaching and the Iraq issues have already been more than sufficient to dampen their credibility.
The current oil shock could add to what is already at stake. Point of seven rich oil-consuming counties is that OPEC could choke off the speculative bubble by adding more supply to the world market.
Adding to the world supply, from the Opec nation's perspective, this could place them on the other corner where price could go against their interests. US officials have put pressure on Saudi oil minister, on his recent visit to US, though he appeared to have taken the stand that the oil price rise is due to the factors other then the Opec control yet he has suggested an increase in oil supply of 2.5 million b/d.
This did little in reducing the tensions in oil market as other Opec members appeared saying that Saudi Arabia alone can not take such a decision.
What worries the major oil producer - Saudi Arabia, is the oil shock of 1970s as it benefited them in the short-run but worked actually against oil producing nations as Japan introduced small compact vehicles consuming less oil and western nations explored other avenues of energy that resulted in a switch from oil or conserving oil consumption, thereby hitting the oil demand.
This bitter lesson of the past forced it to make a heed in supporting the increase in oil production as much as 2 to 2.5 million b/d as this oil shock could further depress the demand for oil in the long run, if western nations started investing in crude substitutes.
The question that why are other OPEC nations opposing as they would also be sharing the same risk. At present, most of other Opec producing nations is already working at full capacities.
Any increase in the oil production would only allow Saudi Arabia to increase production that would led the price down, thereby reducing the benefit being enjoyed by other member nations.
In such a scenario, bottom line equation may worsen for nations producing at near full capacities, as they would be getting fewer dollars even producing extra crude. Saudi stand may not be upheld in the coming OPEC meeting on account of other OPEC nation's point of view that since it's based on market principle it appears to carry more weight.
Market principle, supporter of whom are other Opec nations, seems to override the political pressure arising from Saudi Arabia, which is influenced by western oil consuming nations as long as the other Opec nations able to win on account of market grounds.
Though it won't be a market principle even then a victory of political decision of other Opec nations on the backing of market principle over the political pressure of the west.
The results are yet to be announced on 3rd June when Opec members are scheduled to meet in Beirut, however it is for sure politics would win, no matter who is on the victory podium - consumers or producers.
