A few years ago Russian economy was a basket case with its defaulting on international loans payments and facing international humiliation. Thanks to the oil price boom Russia has become the new energy king and has one of largest surplus reserves of foreign exchange in its history. Putin has understood the role of oil as a most potent weapon and played a key role by his oil diplomacy along with Venezuela and Iran to turn its full impact on western economies with a more deadly impact than nuclear weapons in the cold war.
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by S.K. Sharma
(June 10, Chandigarh, Sri Lanka Guardian) Galloping prices of oil in the international market have severely impacted the financial health of the oil importing countries due to unprecedented inflationary pressure. Crude prices have more than doubled during last one year from $65 to an unprecedented level of $ 139 per barrel. All the financial pundits are perplexed at this exponential growth and nobody is clear as to when this price rise juggernaut will stop.
Some officials associated with oil business are predicting that the oil prices will touch $200 or more. Various reasons such as; natural and man-made constraints in oil supply and demand, lack of spare capacity with oil producers, peaking of oil production, weakening of dollar and role of speculators are being put forward to explain this unimaginable price levels.
One of the most frequently quoted reasons is the mismatch between supply and demand of oil. International Energy Agency March 2008 report showed that there has been a 3.8 per cent increase in oil supply during last one year, which was more than the average of five-year production levels. On the other hand , global oil consumption grew by just 0.7 per cent during this period, the weakest growth since 2001 and half of the last ten year average. In spite of this production increase, the oil price rose by 57 percent during this period and are continuously increasing. There appears to be some other reason than mismatch between supply and demand put forward by the analyst to explain the present surge in oil prices.
Wall Street Journal has attributed the recent price rise to the lack of crude “cushion” in the system at merely 1 per cent amounting to 1 million barrels per day out of total consumption of 85 million barrels per day. Any bottleneck in production as a result of natural or man-made accidents or incidents create a scare in the market resulting in volatile sentiments. This has been effectively refuted by the current president of OPEC, who has emphatically stated that they have at present 3 million barrels per day excess capacity. If the figures of non-OPEC producers is added, the spare capacity is more than sufficient to take care of any major eventuality.
Major oil users of the world like the USA, OECD states and Japan have created strategic oil reserves to tide over these eventualities. Approximately 4.1 billion barrels of oil are held in strategic reserves in the world.It appears that an artificial scare of low spare capacity is being created by the vested interest to further fuel the volatility in oil prices.
Another theory being propagated by the oil analysts is that the world “oil reserves peak” either has already occurred or will occur in 2010/2015 and after that there will be downhill for the oil production capacity. Recent rigorous simulation and modeling done by EIA shows that peak will occur only beyond 2030 and there is no need to get alarmed . This conclusion is being sported by the fact that there has been a net addition of 277 billion barrels in the world oil reserves of 1317 billion barrels between 2000-2007 when net investment in oil exploration was very low. This shows that the prediction of oil doom is far fetched.
The main question then is who is driving the oil price juggernaut, due to which during last three years world has paid an additional $ 3 trillion.
A look at the main oil players shows that there are three distinct entities, namely private companies, OPEC and non-OPEC countries. Due to nationalisation of oil assets by oil producing countries, nearly 77 per cent of the world production comes from national oil companies of different oil producing countries. Many of these have political agenda rather than commercial considerations.
MNCs on their own have a limited role in manipulating oil production on large-scale as only 7 per cent of world’s oil reserves are in the countries which allow these MNCs a free hand. However, they have the resources and expertise in influencing market sentiments by planting distorted analyses through their present and former executives to create doomsday scenarios.
To put oil constraint rumours at rest some oil producing countries need to substantially increase their production. Capacity of OPEC to drastically change the oil dynamics has reduced considerably as 65 per cent of the total world production at present is in the hands of non-OPEC members.
Russia has the largest production levels and spare capacity to change the production dynamics. However, its oil production, which at one point even surpassed that of Saudi Arabia has reduced during last two years. It is debatable whether it was really due to peaking problems, as is being made or a deliberate act for escalating oil prices. The second option looks more plausible as Russia has been one of the greatest beneficiary of the boom in oil prices. It earns an additional $ 2 billion for every $1 increase in the international oil price.
A few years ago Russian economy was a basket case with its defaulting on international loans payments and facing international humiliation. Thanks to the oil price boom Russia has become the new energy king and has one of largest surplus reserves of foreign exchange in its history. Putin has understood the role of oil as a most potent weapon and played a key role by his oil diplomacy along with Venezuela and Iran to turn its full impact on western economies with a more deadly impact than nuclear weapons in the cold war.
Saudi Arabia used to act as a spoilsport in earlier attempts to raise oil prices under pressure from the US. Now it appears to have given its tacit support to new dispensation of oil turks led by Russia to shore up its dwindling economy and insulate itself from reduced returns due to decline of US dollar by 13.4 per cent in the last year.
OPEC claims that their net export revenue per capita is just 55 per cent of what it was in 1981 and there is scope for doubling the oil prices from 2007 level so as to strengthen their own economies. Thus, a figure of $ 200 per barrel is quite plausible in new future.
Some of the OPEC members claim that they have subsidised the world economy for too long at their own expenses. This was the main reason that George Bush could not push Saudi Arabia to increase its production substantially to calm the oil price storm and had to come back empty handed.
The telling impact of oil weapon has given flip to another idea of Putin to form a gas cartel on oil lines to push up gas prices in foreseeable future.
Another faceless but deadlier player than OPEC has emerged on the oil scene in the form of speculators. Oil speculators have stockpiled via the future market the equivalent of 1.1 billion barrels of petroleum, which is eight times the oil the US has added to its strategic petroleum reserves over five years or the increase in demand of oil in China over the last five years, which is growing at the rate of 20 per cent per year. This appears to be one of the major causes of runaway oil prices. According to The Economist, about $ 260 billion has been invested in to the commodity market, which is up nearly 20 times from what it was in 2003. The stimulus has been a small margin of 5-7 per cent required in the US in the commodity market.
The implications of this low margin are that the speculators with a mere $ 260 billion are able to take positions on approximately $ 5 trillion in the future market. It is estimated that oil accounts for more than half of these bets. It is alleged that the oil market has turned in to a gambling parlour.
Four financial companies turned oil traders namely Goldmen Sach, J.P.Morgan Chase, Citigroup and Morgan and Stanley now determine the oil prices and only they are aware who is entering in the oil future market. It is also alleged that staggering oil earning by oil producers are being pumped into future market to further maximise their profits. Analysts also claim that investors ruined by real estate meltdown, stocks, shares and bonds during last one year have jumped into the oil market and are making up their losses. Cuts in US interest rate and hedging against fall in dollar and inflation has also diverted the attention of investors to commodity market.
Seasoned oil analysts claim that out of $ 130 per barrel of oil price, $ 50-60 are the speculator’s premium. Some allege that there may be a tacit support of US government to oil speculators as strategic reserves are being filled to the brim at a time when the oil prices are touching new high, instead of using them to cool the runaway oil prices.
Alternatively, it might be a precursor of some geopolitical event of staggering proportions in the Middle East, which is likely to further escalate oil prices.
This shows that a tectonic shift for determining the international oil prices has taken place where oil producers and speculators are working as a cartel to fuel the oil price fire. The recent meeting of the major oil importing countries is a step in the right direction and they should join hands and devise ways to stem this new trend which will otherwise ruin the international monetary and political system.
The writer is Professor Emeritus, Panjab University, Chandigarh
- Sri Lanka Guardian
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