Oil Price Hike: Reasons and Impacts

RIYADH, 6 September 2004 — Oil prices soared to historical record levels approaching $ 50a barrel two weeks ago, after ranging at about $ 10five years ago. Of course when oil prices go up or down sharply, the number of writers who seek to analyze the market situation and who claim to know all its aspects and secrets will increase. There is no doubt that the current surge in prices was unexpected, as most, if not all forecasts by experts, consultancy firms, energy organizations and companies at the beginning of this year were not expecting that prices would reach even $ 35per barrel. In fact they were predicting just the opposite but what happened was the contrary as a result of some oil and non-oil developments simultaneously and successively. The most important ones of these developments are:

First: The increase of world demand was more than expected, particularly in the United States, China and India and some developing countries. The International Energy Agency predicted at the beginning of this year that the world demand for oil this year would be less than 80 million barrels a day, but it later adjusted its forecast to82 . 2million barrels a day (bpd), with an increase of more than two million bpd.

Second: At the beginning of the year, analyses indicated that new quantities of oil would enter the international market, particularly from Russia, Caspian Sea, West Africa, Iraq and others, but this did not happen in the expected quantities.

Third: The political and labor situations in some oil exporting countries, as political and security instability and the fear of chaos or security problems affected production of these countries such as Iraq, Nigeria, Venezuela and Saudi Arabia. Apart from that the labor strike in Norway and the problems of Yukos oil company in Russia also contributed to creating a state of panic in oil markets, especially with the limited surplus of world oil production capacity, which is currently estimated at about1 . 5million bpd (about one percent of the international market demand).

Fourth: The pressures on the oil products market, particularly in the US, which consumes a quarter of the international production. In the US market, there are problems associated with oil refining and the quality of used oil products. These problems result from the regulations that have affected the establishment of new oil refineries. (Industrialized countries have refining capacities equal to or exceeding the market demand with the exception of the US which has a shortage of up to two million bpd or 10 percent of its needs, and the shortage is met by importing oil that may not always be available at the required standard). These regulations make it difficult sometimes to meet the demands of some US states, thus causing a shortage in the inventory of oil products.

Fifth: The situation of financial markets, for there is an important role being played by the international financial market on the world oil market. This mainly takes place through the investment funds and speculators in the future oil market, who contribute to the rise or decline of prices as per their view of the oil market on one hand and the investment opportunities in the different financial channels on the other hand. The decline of interest rates on many of the main currencies, fluctuations in the stock market together with a decline in dollar value and increase in the demand for raw materials pushed some investors in the future market to sign contracts for the purchase of row materials, particularly oil contracts, a matter which has remarkably contributed to the rise in oil prices.

There is no doubt that the oil consuming countries — industrialized as well as developing ones — have the ability to cut their dependence on oil particularly when it becomes clear that the price rise is due to deliberate action by the producing countries and that may affect negatively their economies. They can adopt policies that will lead to the reduction of their oil consumption particularly at the medium and long terms, and this, for its part, will affect the income and situation of the main oil producing countries. The effective policies taken by consuming countries, particularly in the previous oil rise periods, such as hiking tax on oil products and encouragement of the use of other alternatives and enhancing efficiency of the use of oil and energy. Those policies proved successful not only in reducing oil consumption but also slashing oil demand. The same thing is applicable to several other industrialized consuming countries. A visitor to Holland today will notice high rate of the use of cycles as a result of a policy encouraged by the government 30 years ago, with the aim of reducing oil imports. The industrialized countries have succeeded in this matter in the previous years, and this success is not limited to the slowdown in the growth of oil demand and shrinking of the positive relationship between economic and oil demand growth. It also led to the increase of production in new areas, as the demand for OPEC oil declined from 31 million bpd in 1979 to 15 million bpd in 1985, i.e. more than half, while the production of Saudi Arabia declined from more than 10 million bpd in 1980 to about three million bpd in1985 .

What may lessen the impact of the current crisis and make it different from the previous crises is that most people are aware that the current oil price hike is attributed to several factors, none of them dominant, and it is not an issue of conflict between producing and consuming countries nor has it come about as a result of deliberate actions by producers.

The main challenge facing the Kingdom is non-dependence on one commodity — despite of its importance and price — as a single source of national economy with all its dimensions (state budget, balance of payments and gross domestic product), particularly when this commodity is liable to great fluctuation not only in its prices but also in its production. Thus comes the importance of the Kingdom’s efforts to stabilize international oil market not only in terms of prices but also in terms of balancing demand and supply. It also works to ensure adequate supply and establish close cooperation with oil producing and consuming countries.

This leads us to talk about current prices and the possibility of their remaining high. Talking about the possibility of the continuation of prices at the current level or around it is doubtful especially in the medium term, because market principles are not based on such an assumption.

Before concluding this article, I would like to mention that we live in an international market where the interests of all its parties are interrelated and affected by one another. When oil prices increase, they will have negative impacts on the international economy. When the international economy shrinks, the oil demand will decline and vice versa, i.e. when the international economy grows, the demand for oil also grows.

The trade logic compel producers to concentrate on their present and future interests, most importantly taking care of end consumers and not to enter into conflicts with others as this may lead to opposite results on the long run. We, as oil producers, should not resort to political assumptions like talking about conspiracy or about assumed political dimensions not supported by known facts as they may keep us away from the economic and technical facts of an important industry and trade like oil.

(Dr. Ibrahim ibn Abdul Aziz Al Muhanna is an adviser in the Ministry of Oil and Mineral Resources.)

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Ten specious fallacies on current world's high oil prices

The world is facing a high-oil-price era, in which the oil price per barrel will never be as low as a book.

With little say in fixing the international oil prices, China faces a relatively unsafe situation in terms of oil supply.

Energy, especially oil shortage, has been a known subject over the years, so high price is only a matter of time. The current high oil prices just vindicate this point. As the oil competition is turning more and more heated, the oil prices shoot up as well, pushing a new round of "transfer" of global resources and wealth and forcing renewed understanding of the oil and the high prices.

However, people's views on a certain phenomenon may often turn to the phenomenon itself. The anxiety, tension and panic induced by the oil prices permeate between the markets and the governments, which in return makes it harder for people to understand the international oil market itself. In other words, the view about the high prices is now specious.

Fallacy No. 1: No oil price rise any more

The oil price, waving around US$ 40 per barrel since 2004, and topped US$ 50 in August, and then dropped continually these days. Some people may take a relief from this. The waves of oil price mirrors a monetary phenomenon, that is, the US$40-per-barreal price actually equals the US$ 28 in 1990 and US$ 18 in 1980, which allows unpredictable room for increase. The world is facing a high-oil-price era, in which oil will never be as cheap as a book.

While oil price can be settled, the drought is irresistible. With the depletion of oil resources, there will never be any cheap oil. Many scientists and engineers in the world project that the outputs of oil and natural gas will peak one after another in the first two decades of the 21st century, which means the present oil price is not overestimated but underestimated. The prediction by French Institute of Petroleum in August is that the oil price will linger between US$ 30 to 80 per barrel.

The future oil price rise will not be gradual but high jumps in price may come often, which will not seriously affect the poorest countries who after all have not money to buy resources, neither the richest ones, who can buy a barrel of oil at a price of US$ 100. However, the rest, especially those relatively larger developing countries, will suffer severely

Fallacy No. 2: People's worry is caused by oil price staying high

What worries people most may still be the uncertainty of oil price, which will push it to sprint to another peak. Most heavyweight experts made wrong predictions on the price of crude oil in 2004. Those who predicted "stable and lower-turning for oil price" will be stunned, or at least feeling so now.

Iraq has not resume its oil production, let alone to enter the international market; non-OPEC (Organization of Petroleum Exporting Countries) countries such as Russia still have limited potential in output growth. All these tell a tendency known to all: various sides are all intending to keep the oil price at a high level for a long time. As for the uncertainty, the best exponent is Iraq: the US-led war against Iraq was interpreted by the economists as the "beneficial" to the world economy, because of uncertainty chased away, it is an indisputable fact that the world economy will revive thereof.

The field of oil features uncertainty. Under heated contention, the structure of the oil market in the next five to ten years cannot be prophesied. Who will become the major oil supplier in the global market, the Middle East, Caspian Sea, Africa, or Russia? No one knows. Whatever the answer is, it surely has much bearing on the oil sources of the United States, Japan, India, China, and the oil battle among them.

Fallacy No. 3: Diversity of oil import means de-Middle East strategy

The "free-from-Middle East strategy" is sheer cheating. Although Washington has formulated ever since the 1970s plans of less dependence on Arab oil and seeking energy sources from outside the Middle East, it does not bring any results and change the situation of the world's oil supply either. In the entire Middle East, what the United States coverts most is Iraq's oil because it takes US$ 2, the lowest exploration cost in the world for each barrel of oil, due to layer extremely close to the ground there.

Let's see some statistics in the report entitled "Energy Resource Development of the Middle East" delivered by the International Institute for Strategic Studies in Washington early this year. In 1978, the proven crude oil reserves in the world reached 648.3 billion barrels, among which 405.7 billion, or 63 percent, were in the Middle East and North Africa. In 1988, the global reserves reached 917.8 billion, and 608.1 of which, or 66 percent, were from those regions. In 1998, 716.2 billion barrels accounting for 68 percent of the total 1,052.9 billion barrels were there. By the end of 2002, while the world reserves decreased to 1, 047.7 billion barrels, that in the Middle East and North Africa even reached to 7 28.3 billion barrel, accounting for 70 percent of the whole. The conclusion drawn in the report was that the Middle East situation would affect the world's energy balance between supply and demand.

Various data indicate that in the next twenty years, unless substantial changes in the demand of world's energy resources, the Middle East will still dominate the international oil market.

Fallacy No. 4: Oil producers are center for fixing international oil price

After the fourth Middle East war broke out in October 1973, the oil producers, mainly the OPEC countries, took a series of measures including resuming the right in oil pricing, raising price, cutting output, embargo and nationalization, which not only guaranteed their due income, but also for the first time dealt a heavy blow to the Western developed countries with oil as weapons, and ignited the economic crisis in the capitalist world during 1973 and 1974. Since then, the oil setup changed as the developed countries such as the United States, Japan and those in Europe paid more and more attention to controlling the oil sources.

Practice of the developed countries is a combination of politics and economy: oil capital streaming in the path cleared by political and economic touches. Expanding oil demand worldwide makes the pricing in the international oil market an important means to control the oil strategies. Although the price is generally settled in the international crude oil futures market according to the supply and demand, the powerful financial markets in the United States and European countries, particularly the superior US currency, determined that dollar is the pricing unit in the international crude oil futures market.

Meanwhile, the United States retarded in exploiting domestic resources and imported hugely as the world's first oil buyer. This situation laid a foundation for it to control the scale of oil need and set price. Japan has made it a strategy to seek a Japan-dominated transporting-reserve-pricing oil security system and maximum independence on other countries.

As to China, with no say in international oil pricing, it will face relatively severer insecurity.

Fallacy No. 5: The world won't be caught unprepared by expensive oil

As one of the satisfied scholars seeing no harsh impact by the high oil price, economic professor James Hamilton at the University of California, San Diego, held that the world has progressed in precaution price waves and is ushering in the new era.

What he neglected is: it was just because of the world's robustly resurrecting economy that pulled up the oil price, not the reverse way. Due to the retardation of oil price rise, the high price and its ripple effects will more and more jeopardize the world's economy, which, with no adjustment, will turn to turmoil.

Sooner or later, a new round of energy crisis will change the international oil structure. Oil in pipelines is likely to change the whole world.

Fallacy No. 6: China a pusher behind

Well at ease in their "catching-up" strategies, developing countries will surely go panic and suffer payment losses. Take China for example, this round of price hike proved again that China has been zigzagging in its external energy path, an exponent of which is the extremely uncertain oil market now.

Five years ago, the international oil price skyrocketed when China bought in a large amount; three years ago, it dropped as China cut its import. One year ago, the Iraq war led to price premium, and later, the reasonable price expected was finally swallowed by the prodigious need in energy aroused by the world's reviving economy.

At that time, international oil giants targeted on China, an expanding economy seeking oil suppliers and preparing to build oil reserve bases. As a strategic buyer, China will mind the price. It is characteristic in the international oil price that the price of futures determines that of goods. China lacks necessary oil futures and market practice, therefore, as international oil speculators see it, has to be trapped in building up strategic reserve at a high price.

China is an absolute victim of high oil price. What it will profit from the uncertainties in the international oil market is lessons to be drawn on and independence to be achieved.

Fallacy No. 7: Russia's counts only on oil for resurgence

Russia benefits from global oil contention: the daily oil output in July jumped from 6 million to 9.3 million barrels, a record since the post-Soviet Union period. Russian President Putin is now reshaping the nation's oil industry, consolidating the government's control over it, which can be on a par with the top producer Saudi Arabia. Russia also intends to recreate its image as a weighty power on the international stage.

However, Russia needs to take care not to be wrong footed by the huge profit in its development. Obsession will lead to unworthy deformation.

Fallacy No. 8: US-led war was not for oil

The US-led war on Iraq was laughably interpreted as defending the Western freedom and democracy. However, it was for the oil there. Just like Dr. Kissinger once said, oil is too important to be left to the Arabians.

It is a long-term national policy of the United States to control the Middle East for the sake of the global dominance. The White House once discussed the feasibility of sending forces "to protect the oil countries in the Middle East" upon the oil crisis in 1974 and 1975. As "Iran Revolution" broke out in 1979, President Carter uttered in the State of the Union Address in January 1980, that any country intending to control the oil in the Middle East will be regarded as infringing upon the interest of the United States, who will take all measures, including force, to protect it. In 1990, Cheney, then Secretary of Defense, said, the root why Iraq was not allowed to swallow Kuwait, was that the 20 percent of the world's proven oil reserves were not hoped to be left to Saddam, who is hostile to the United States.

The US policy is based on an important assumption: the one who controls the oil in the Middle East grips the economic throat of the United States.

Fallacy No. 9: oil price is purely an economic matter

The question is essential that powers want to control oil, and control is of politics.

In terms of economy, the United States controls the oil thus enhancing the "oil dollar" position. Presently, US dollar has kept dropping, which will potentially make the oil producers consider pricing with Euro. Actually OPEC members have now shown such an inclination, which is probably a bad news to the United States. If so, the oil importers will absorb Euro to deal with balance of international payments. This means that dollar shares, debts and direct investment will be abandoned, and the exchange rate of US dollar will drop a lot, thus lead to chain crises such as dollar depreciation and US economic recession. The saying of the collapse of capitalist "fortress" is not exaggerating.

Politically, US strategy is to open, enter and finally completely occupy the oil market, with strength or in a military way. This is a kind of predatory and exclusive view on oil security. Reality indicates impossibility of monopolizing. Economic globalization has been the trend of world's development and oil market cannot be freed from the mainstream. The world's resources can be rationally distributed and used only through cooperation between the sellers and buyers, among the competitors, and interests of various sides have to be met through mutual acceptance, merging and overall balance.

Fallacy No. 10: Strategic oil reserves not equals oil reserves for war

Oil contention will turn more and more fierce as needs are growing and so is the price. In this sense, strategic oil reserves are to some extent oil reserves for war.

Not long before, Washington Post carried an article by a US energy expert. The world is at the frontier of a new type of war, in which countries owning adequate energy resources versus the other are those, with inadequate resources, more and more willing to seek from outside. He also predicted that the war for the last rich oil and gas resources is likely to be the main topic of the geopolitics in the 21st century.

For China, it is not the danger but the unawareness of the danger that is dreadful. The present understanding of the high oil price may be this kind of danger. The structure of the international oil market shows, China's searching for oil will not be easy so we must train ourselves to survive the squeeze to stand out among contenders.

This article relayed from China Youth Daily is translated by People's Daily Online
http://english.peopledaily.com.cn/200409/07/eng20040907_156168.html

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