It may seem hard to believe now, but
for more than half a century, world oil prices have not moved much around
the average figure of US $27 per barrel in 2007 price terms. The occasional
shifts away from this average have been few and the periods of oil price
spikes were relatively short, with the most notable being the OPEC-induced
"shocks" of 1970s. Between the mid-1980s and 2003, the real
price (that is adjusted to inflation) of crude oil on the major international
trading exchanges was typically less than $25 per barrel.
The recent rise in the price of oil began in 2004, when it became evident
that the US invasion of Iraq was going to be ineffective in securing Iraq’s
oil reserves for the US. However, even then the price rise was substantial
without being a surge. It is really only in the past year that the global
oil price has behaved like a runaway horse, breaking all speed limits
and previous barriers. In the three years between January 2004 and April
2007, the oil price in nominal dollar terms increased by around 2.3 times,
to $65 a barrel. But in the period between then and early June this year,
that is just 14 months, the price more than doubled again, to reach a
peak of $139 per barrel on 6 June before coming down very slightly to
$132 on 10 June.
A price of around $100 per barrel in 2007 prices would be equal to the
maximum achieved in the post-World War II period, in 1980. So the global
price of oil is now higher in real terms than it has been since the 1920s.
And the rate of increase of oil prices in the past year has been the fastest
ever recorded. Also, there seems to be no ceiling in sight: some market
analysts have gone on record to predict oil prices of $150-200 per barrel
by the end of the year.
This has already spawned a mini-industry of explanations as to why this
has happened. And, just as in the case of global food prices, the various
explanations reflect not so much the clear empirical evidence so much
as the interests of those presenting them. Thus, it is common for policy
makers and commentators in the developed world to argue that the current
high oil prices are essentially the fault of the developing world: a combination
of supply cutbacks by OPEC and increased demand from the rapidly growing
economies of China and India.
However, both of these factors, while they may at some point in future
play a role in changing the long-term conditions of the world oil market,
have next to nothing to do with the most recent increase in oil prices
over the past year. But to understand this, it is necessary to consider
each of the most commonly advanced arguments in turn.
Most of the explanations deal with supply conditions. One argument that
has been around for a while is that of "peak oil" – the position
that global oil reserves are running out, and may have already peaked
or will shortly peak. The most extreme proponents of this position also
believe that more investment in exploration will do little to change this
imbalance, and therefore the world must learn to shift to alternative
forms of energy, whether fossil based or renewable. In this perception,
the current spike in price is simply the inevitable effect of more than
a decade of denial, which is making the inevitable adjustment that much
sharper and more painful.
However, for this to be true, it should be reflected in growing imbalances
between actual consumption of oil and global supplies. But this is not
the case, as will be evident below.
Then there are those who note the more proximate effects on supply of
particular political and economic trends. The continuing instability in
Iraq continues to affect its production and exports of oil. Recent terrorist
attacks in Nigeria have reduced drilling and production in that country.
Production is falling in Venezuela because of aging oil fields. Tensions
in the Middle East, whether because of fears of an Israeli attack on Iran
or continuing conflicts in Palestine, are also said to have an impact
on oil supplies and therefore prices.
A slightly different argument posits that the falling value of the US
dollar affects oil supplies, because the oil trade is generally denominated
in dollars. This makes producers prefer to keep the oil in the ground
rather than extract it to be paid in depreciating dollars. However, this
argument is flimsy, not only because it is not essential to denominate
the trade in dollars, but because there is no real evidence that the fall
in the US dollar is linked to suppliers' behaviour. Indeed, it may be
more likely that the causation may be the other way around – that rising
oil prices cause dollar depreciation by pushing up the US import bill.
The more ridiculous of the supply-side arguments is the one that blames
OPEC for the current situation. This view is more common than might be
expected: Prime Minister Gordon Brown of U.K. has railed against the "scandal"
of the continuing market power of OPEC and the US Congress is actually
trying to bring a lawsuit against OPEC for cartel-like behaviour and price
manipulation! This remarkably stupid move ignores that fact that since
the 1980s, OPEC has not fulfilled the basic requirement of a cartel: a
mechanism to enforce quotas upon its members.
In fact, today OPEC is more like a club of some oil producers, rather
than a cartel that is in command of world oil supply. It controls only
about 40 per cent of world oil production, compared to 70 per cent in
the early 1970s. And it has been remarkably inefficient in imposing any
kind of production quota on its members, who have happily increased or
decreased their production as they wished. Most of its members are producing
exactly as they would if OPEC did not exist. And in any case, OPEC has
been around for more nearly five decades, and for most of that period
the world oil price has been around $27 a barrel.
The argument appears even more foolish once it is known that the slight
decline in global oil supply in April 2008 (compared to a year ago) is
entirely because of non-OPEC oil exporters, since the supply from OPEC
countries was actually higher by 1.7 million barrels per day. In any case,
the Oil Minister of the largest OPEC producer, and indeed the world largest
oil producer, Saudi Arabia, has already announced that “any demand for
extra production capacity from consumers will be immediately met",
so it is somewhat bizarre to blame the current high prices on OPEC.
The other argument popular in the North relates to demand, and suggests
that the voracious demand for oil in China and India – which in turn is
fed by heavy state subsidies that keep the domestic prices of fuels down
– is responsible for the recent price surge. This argument appears to
be superficially plausible, but once again it is fallacious. It is true
that China’s demand for oil, in particular, has been increasing rapidly,
but it still accounts for less than 8 per cent of global consumption,
and India for less than 3 per cent.
The current obsession with subsidies ignores the taxes imposed on petroleum
prices that affect retail domestic prices. In fact, despite recent increases,
the US still has among the lowest domestic prices of fuel in the world,
substantially lower than India even in nominal terms. Relative to per
capita GDP or actual purchasing power, the domestic retail prices of oil
and oil products in India and China are many multiples of the prices prevailing
in the US. So the subsidies leading to excessive fuel consumption are
much more prevalent in the US than they are in India or China.
In 2007, import demand from China and India together increased by 8.7
per cent, but import demand from the other five large importers (US, Japan,
Germany, France, Italy) actually fell by 2.6 per cent. As a result, demand
for oil from the top ten importing countries actually declined by 0.5
per cent. Even so, the global oil price increased by 170 per cent!
The scenario appears to be similar in the current year. According to projections
of the Energy Information Administration of the US Government, OECD oil
demand will contract for the third successive year in 2008. While non-OECD
demand growth in 2008, led by China and the Middle East, will remain reasonably
strong at 3.7 per cent, aggregate global demand will increase by only
1.2 per cent. Supply is expected to be approximately the same as the previous
year, at around 86 million barrels per day. Yet in the first five months
of this year, global oil prices have increased by more than 140 per cent.
From all this it is quite evident that the straightforward explanations
based on real demand and supply are simply not useful in understanding
the current price hike. Rather, the price for this very physical commodity,
this universal intermediate, is now determined in the virtual world. In
other words, speculative forces, operating especially through the commodity
futures markets, are driving the current oil price surge.
Just as in the case of other primary commodities, financial deregulation
has played a role in allowing this to happen. Two major international
exchanges are crucial to this process. The New York Mercantile Exchange
(NYMEX) and the Intercontinental Exchange (ICE) in London control futures
contracts on two of the most widely traded grades of oil: West Texas Intermediate
and North Sea Brent. This becomes a benchmark for spot prices of actually
traded cargo. For the past few years, the oil market has been operating
in what is known as "contango", meaning that futures contracts
for oil are priced higher than oil directed to spot delivery. As futures
prices keep rising, they push up spot prices as well, regardless of the
ground situation with respect to actual consumption and actual supply.
The problem is that the futures market is largely unregulated, because
of the growth of OTC (Over the Counter) electronic markets that were allowed
in the early years of the decade in the US, and because the ICE in London
is also not subject to regulation. As a result, this has led to “a process
so opaque only a handful of major oil trading banks such as Goldman Sachs
or Morgan Stanley have any idea who is buying and who selling oil futures
or derivative contracts that set physical oil prices in this strange new
world of "paper oil."
(F. William Engdahl, http://www.globalresearch.ca/index.php?context=va&aid=8878)
The problems with such unregulated markets have been evident for some
time now. In June 2006, a US Senate Permanent Subcommittee on Investigations
published a report on "The Role of Market Speculation in Rising Oil
and Gas Prices" (the Levin-Coleman Report). This was largely ignored
by the media and indeed by US policy makers, but its findings have great
relevance today. Some of its conclusions are worth quoting in detail:
"There is substantial evidence supporting the conclusion that the
large amount of speculation in the current market has significantly increased
prices (because of) a tremendous growth in the trading of contracts that
look and are structured just like futures contracts, but which are traded
on unregulated OTC electronic markets". As a result, the Report noted
that there has been a significant reduction in the possibilities of market
oversight. "With respect to crude oil, the influx of speculative
dollars appears to have altered the historical relationship between price
and inventory, leading the current oil market to be characterized by both
large inventories and high prices."
Because it is so unregulated, it is not even possible to figure out who
the major players (and therefore major beneficiaries of the oil price
rise) are, but it is clear that oil producers are not benefiting much
even as oil consumers suffer. It may well be that, in addition to financial
institutions that have specialised in commodity futures trading, large
transnational banks that have burnt their fingers in the US housing market
and desperately need to recoup their losses are entering this market and
driving up prices to make quick speculative gains.
There is some evidence of the involvement of large players in this market.
Goldman Sachs and Morgan Stanley are the two leading energy trading firms
in the United States. Citigroup and JP Morgan Chase are major players
and fund numerous hedge funds as well who speculate. In the past five
years investment in index funds tied to commodities has grown from $13
billion to $260 billion. Hedge funds, investment banks, pension funds,
and other professional investors increasingly direct their financial resources
into oil and other commodities. This is supposed to create a hedge against
inflation, but of course it ends up contributing to it.
Such speculation has become the most profitable form of financial activity
as well. According to HSBC, commodity and energy weighted funds topped
the list of "best performers" in the financial markets in the
past three months, generating on average more than 30 per cent annual
returns even as other hedge funds suffer losses.
There has been some belated and minimalist policy action against this
tendency. On May 30, responding to much criticism, both NYMEX and ICE
London tripled "margin calls" for their contracts, forcing traders
to deposit more money when investing. It is after that that the price
per barrel of Brent Crude oil fell from $139 to $132, suggesting that
it may have had a minor impact in curbing extremely speculative activity.
So, just as for major food grains, deregulation of financial markets has
had a significant role in affecting global oil prices. Therefore, it is
likely that the current oil price spike reflects a speculative bubble.
If so, like all bubbles, it will eventually come to an end. Of course,
this bursting of the bubble may take longer than could be expected – remember
that the US housing bubble carried on for several years – but even so
it is essentially transient. This means that policies in developing countries
must also factor in this possibility, especially before trying to pass
on the adverse effects of the oil price hike on to the working people.