Oil price trajectory

Hyperbolic price swings with huge upward bias portend threats to our future security


Graphic credit: WTRG Economics

If you take a look at the oil price tracker I display at left and the image above, you'll see that oil has broken through the $50 level again. When these price spikes happen (two days ago the move was +6%, with another strong upward move in process today), the business pages fill with momentary explanations.

Bloomberg coverage is always useful for reports not just on the momentary factors, but on some of the underlying factors as well. Today they report,

Crude oil rose to a four-month high, approaching $52 a barrel in New York, as a Siberian cold front gripped western Europe and forecasts called for freezing temperatures in the Northeastern U.S.

The surge in heating-fuel demand may drain inventories of heating oil and diesel. U.S. supplies probably dropped last week by 1.75 million barrels, according to a Bloomberg survey of forecasts before the government releases weekly estimates later today. Surging demand may strain supplies this year, with only OPEC able to pump more oil.

``It's mainly the cold snap that's added $4 or $5 to prices, particularly with Europe having a freeze from Siberia,'' said Jason Kenney, an analyst at ING Financial Markets in Edinburgh. ``The market is concerned that Russian supply growth won't be outstanding and that China is drawing a lot of oil. For prices to come down, you need for supplies to go ahead of demand.'' ...

Slowing growth in oil output from countries outside the Organization of Petroleum Exporting Countries means OPEC will have to pump almost as much as it can to meet demand. That will use up spare capacity and make it harder for the group to compensate for any disruption to supply.

The strain in supplies and the cold spell are leading speculators to bet prices will keep rising. The strain in supplies and the cold spell are leading speculators to bet prices will keep rising....

There you have it, OPEC is reaching the limit of its swing production role while everyone else is "slowing."

Okay, so let's review. Almost one year ago the $27 to $37 trading range for oil was left behind. For good? I don't know, but all market biases are pointing towards $60 oil, not $30 oil. It looks like the speculators are betting up anyhow. But eleven months ago today, we heard analysts saying, "...oil prices are likely to remain high, and could peak..."

Where? "...around $40 per barrel."

Then what happened?

Let's follow the pattern
May 2004. The all-time oil price record was set in the low $40s. In early June OPEC holds a meeting where Saudi Oil Minister Ali Naimi tells reporters there is no problem, OPEC will raise its production ceiling by 2 million barrels per day. Prices sag into July, but begin a sharp upward march in mid-July.

August 2004. Near panic sets in on August 3 and 4. The price of oil ended up close to $48 as Indonesia's Purnomo Yusgiantoro, OPEC's president, said, ``The oil price is very high, it's crazy. There is no additional supply." and Algerian Oil Minister Chakib Khelil said, ``OPEC can do nothing." At this point the legendary former Saudi oil minister Sheikh Ahmed Zaki Yamani steps up to try to end this speculation, saying, "There is additional supply available from OPEC -- you will definitely see it." Prices dropped sharply to about $42 by early September.

October 2004. After a month of another steady upward oil-price march punctuated by several Atlantic hurricanes, a several-week-long panic cycle takes hold in late September through late October. The price touches $50 by September 28. Bandar Bush and the Saudis respond with what is billed as new oil supply, but it is sour crude, high in sulfur. Meanwhile, the G8 finance ministers hold a weekend meeting in early October. Deeply rattled, they express concerned about the "transparency" of oil supply data, while issuing a statement that suggests the world needs to start controlling energy demand in the face of the questionable sustainability of supply. Oil broke $55 by October 18 and hit $55.67 before closing at $55.17 on October 22. But as the effects of the September hurricanes wore off a bit and supply firmed up a little, the oil price fell back to $46 into mid-November.

November 2004. With prices easing slightly, the market experienced a wave of doubt about the ability of the Saudis to maintain daily supply volume. A recently retired Aramco official, Sadad Al Husseini, was quoted by British television on October 26 that American government's forecast for future oil supplies are a "dangerous over-estimate". Following that, CNN International came out on November 24 with a widely quoted story asking, "How secure is Saudi oil?: New questions on the vulnerability of the country's vast facilities and how markets would react". The oil price spiked near $50 again. This was too much for the Saudis, who again stepped up with a PR campaign designed to calm markets. A Bloomberg story on November 29 reported remarks of Saudi oil minister Ali al-Naimi, who said that Saudi Arabia had plans to expand output capacity by 14 percent to ease concern of potential shortages. ``We are producing 9.5 million barrels a day, and we would be ready to produce 11 million if a buyer showed up,'' al-Naimi said. ``Where is it? There is no shortage of supply in the market.'' Within days the oil price slid sharply, as it appeared that some supply headroom had appeared, despite continued concern over heating oil inventories. But in December the lowest bottom could reach only about $41.

December 2004. A surprise occurred on December 10 when OPEC, meeting in Cairo, "agreed to collectively reduce the over-production by 1.0 mb/d from their current actual output, effective 1 January 2005". Following this announcement, there was a brief spike to about $46. Very confusing -- the Saudis said it would raise production, but OPEC then moves for cuts.

2005: So far, the pattern of 2004 is continuing into 2005. Signals in two directions emanate from OPEC and the Saudis -- there is enough spare capacity, even to the point where cuts in the ceiling are contemplated, but then it's reported that ``OPEC will have to pump almost as much as it can to meet demand". Meanwhile, the G-7 ministers have repeated their October statements at meetings in London three weeks ago. In a new statement released February 5, the ministers say,

...the risks of current oil prices. Market transparency and data integrity is key to the smooth operation of markets. We welcomed concrete actions in improving data provision to oil markets and encouraged further work, including on oil reserves data, by relevant international organisations. The Extractive Industries Transparency Initiative can increase fiscal transparency and help improve the use to which oil revenues are put. We call on international institutions to work with oil producing countries to ensure a climate conducive to investment. We recognised the importance of raising medium-term energy supply, of energy efficiency, and of the importance of technology and innovation in ensuring energy security.

A short but perceptive piece by Jad Mouawad rounding up oil in 2004 and looking to the future in 2005 was published in the New York Times business section on January 3, 2005. In it, Mouawad writes,

It was a year that people in the oil markets are unlikely to forget - a year that prices set records, forecasts lost touch with reality, and almost everything that could go wrong, did. It was also a year that politics returned to the oil market.

And the trend is likely to continue this year. While oil prices have declined since October, many of the issues that have vexed the oil industry in 2004 are expected to recur. Cheap oil increasingly looks like a thing of the past.

Through the 1990's, prices were stable, supplies were secure and there was plenty of extra capacity to keep energy costs low and world growth buzzing. At an average of $20 a barrel, oil was viewed as just another commodity.

But then came ethnic and labor troubles in Nigeria; chaos and protests in Venezuela before President Hugo Chávez won a referendum allowing him to stay in power; hardball energy politics in Russia; and the continuing insurgency in Iraq.

While supplies of oil to the world markets were rarely interrupted, the uncertainties created by these events raised crude oil prices in New York by two-thirds this year, to a high of more than $55 a barrel in October. And as energy costs surged, many analysts, traders and politicians woke up to the reality that oil was different from cocoa or coffee.

Yes, it is a different, frightening world we are entering. Confusion reigns as secrecy shrouds the truth about oil supplies and mixed signals swing markets to and fro. The signs of a looming, full-blown collision of petrochemical- and technology-based economic growth and the limits imposed by planetary resources should be obvious to anyone who has watched the trajectory of the oil market over the last year. Unfortunately, the risks are enormous. Conflict over strategic resource interests and rapidly accelerating environmental harms are the threats with which we all find ourselves enmeshed.