Will oil soar to $75/barrel?

<div class="section0"><div class="Normal"><span style="" font-size:="">I have long been a pessimist on oil prices, and so far have been vindicated. Oil last week hit a record $58/barrel even though this is the slack season (winter demand for heating oil is ending in the Northern Hemisphere, and summer demand for petrol is yet to come).</span><br /><br /><span style="" font-size:="">As petrol demand rises in summer, and heating oil demand rises again in the coming winter, could oil prices cross $75/barrel? Quite possibly.</span><br /><br /><span style="" font-size:="">A Goldman Sachs analyst has warned that in extreme circumstances, the price could spike to $100/barrel.But even if circumstances are not extreme, even if we see no terrorist attacks, no strikes and no supply disruptions, I suspect prices will keep rising.</span><br /><br /><span style="" font-size:="">Why? Because, there is a fundamental supply-demand imbalance for oil in the world economy. Production is just about enough to meet demand. There is no spare capacity to take care of unforeseen shutdowns, supply disruptions, or a further rise in Chinese demand.</span><br /><br /><span style="" font-size:="">No major oilfields have been discovered for years. Ever since the price of oil fell to just $10/barrel in 1998, oil companies have invested very little in exploration and refining. Till last year, the oil industry invested on the assumption that the price of oil would not exceed $20/barrel in the long run. Lack of investment for years means that global production is not in a position to meet burgeoning world demand. Even if crude inventories rise (as in the USA recently), refining capacity is insufficient, so petrol is scarce.</span><br /><br /><span style="" font-size:="">High oil prices today represent a demand-driven imbalance, not a supply-driven one. The previous three oil spikes in 1973, 1980 and 1991 were all on account of supply disruptions in war contexts. These led to global recessions that reduced oil demand and prices to more moderate levels.</span><br /><br /><span style="" font-size:="">But this time there is no supply shock. World output is rising steadily, though slowly. However, demand is galloping in China (and in India and other Asian countries to a lesser extent). The world economy grew at 5.3% last year, the fastest rate for three decades. The consequent rise in demand has taken everybody by surprise. Supplies are inadequate even though every OPEC producer save Saudi Arabia is producing flat out. Most estimates suggest that Saudi Arabia has only a limited ability to raise production in the immediate future (maybe one million barrels/day).</span><br /><br /><span style="" font-size:="">No recession is in sight despite high oil prices. One reason is the huge trade and budget deficits of the US, which have pumped out enough dollars to enable the world economy to pay more for oil and yet keep growing. A second reason is that world GDP is far less material intensive than in earlier decades, so even a sharp rise in commodity prices (of which oil is only one) has generated only modest inflation.</span><br /><br /><span style="" font-size:="">In the short run, the absence of high inflation will encourage consumer spending, helping ward off a recession. The bad news is that rising consumer spending will probably send oil prices even higher, to the point where it really hurts.</span><br /><br /><span style="" font-size:="">Many analysts argue that oil now forms a very small share of household consumption in the rich West. So, they argue, a global recession (caused by falling consumer demand) is unlikely at $58/barrel, and may not occur at all unless the price rises to $75/barrel.</span><br /><br /><span style="" font-size:="">I suspect this is too optimistic: a recession could occur at a lower oil price. But if oil really needs to hit $75/barrel to cause a recession, then I suspect it will indeed hit $75/barrel. Why? Because nothing short of a recession in the USA looks like bringing down global consumption and thus rectifying the fundamental supply-demand imbalance in oil. There is little chance of China and India reducing their consumption right now: they are growing rapidly and have rising forex reserves in the face of record oil prices. Any slowdown will have to originate in the West.</span><br /><br /><span style="" font-size:="">Some optimists argue that, provided the US keeps running ever bigger trade deficits, the world can keep growing even at $75/barrel oil. This may work for some time. But surely this reprieve will be temporary, and will in due course push oil even higher, towards $100/barrel. Flooding the world with dollars cannot solve a fundamental supply-demand imbalance for oil.</span><br /><br /><span style="" font-size:="">Now, some optimists believe that Saudi Arabia has the ability to increase production very substantially within a year if it so wishes, and that this can bridge the supply-demand gap. I can only say that I have yet to see concrete evidence of this.</span><br /><br /><span style="" font-size:="">I know that oil prices are notoriously volatile, and have made fools of many forecasters in past years. Nevertheless let me stick my neck out and predict that oil prices will keep rising, and may touch $75/barrel within a year.</span><br /><br /><br /><br /></div> </div>