CAN YOU CATCH THE WIND, PREDICT OIL PRICES?

 By Ademola H. A. Siole-Balogun

REALITIES OF GLOBAL RESPONSE TO OIL MARKET SUPPLIES                            

There is a debate as to what exactly promotes the recent oil-shock that has been witnessed in the international oil markets and whether the global response to it has been a function of excessive demand or other externalities which combine to create oil shocks, ultimately benefitting the producing nations and oftentimes to the detriment of the global economy. Research has shown[1] that since 1973, the real reasons and effects of oil shocks have not only been in the form of an abnormal demand or supply functions, but majorly by speculative demand shocks. The logic[2] is that the oil supply shocks have had little effects on oil prices since the period in question; rather the combination of speculative demand shocks to the price of oil globally as well as the global business cycle contributed immensely to the swing in the price of oil severally from 1973.

This was particularly evident in the aftermath of Yom Kippur war 1973-74; Iranian Crisis 1978-80, and lately between 2003- 2008 in which the prices of oil rose to an all-time high of $147.00.

It may thus be the case, without running the risk of making a value-based judgment, that global business cycle has played more than a passive role in the response of the global market to changes in the price of oil. For instance, in the period of 2003-06, the increase in demand of oil was attributable to the economic growth and expansionary activities of several Asian countries, notably China and India. Equally, the massive recession occasioned in the period of 2008, may have led to the drastic drop in the prices of the commodity in the international market for the period in question.

THE TREND IN US DEMAND FOR OIL: OPPORTUNISM VS MARKETS    

While the demand for oil surged in the 1950s, coupled with the increased production by the IOCs, the reverse was the case a decade later. The US domestic energy policy changed as a result of the fact that it stopped being a net exporter of oil as a result of cheaper production from the Middle East, prompting President Eisenhower to declare that the national security of America was in jeopardy if it continued to rely on cheap foreign oil for its domestic consumption., thus imposing an import quota for the country! This quota in question then kept the price of crude oil in the American domestic market artificially high and still higher than the world market prices. Consequently, by 1970, while the international or world market price of crude oil stood at $1.30, the US domestic refiners were buying crude oil for thrice the price at $3.18 per barrel[3].  

However, the history of oil production had at its head the control of global pricing of oil by the US economy. The As-Is agreement as a pricing system had its base as the prices obtainable from the sale of domestic oil products in the US and thereafter named- Gulf Point Basing Point System. Where the other origins of oil, other than the US markets could deliver crude oil at cheaper amounts, an additional or phantom freight would be built into the final cost to bring it at par with the price fixed by the Gulf Point system. This is the sore point of the question raised about opportunism versus markets; How could the opportunism of the US at the point in history be overlooked in the interest of market forces? When the US, through the IOCs, prior to 1950, controlled the global price of oil, it could not have argued that it posed a danger to the national security of its consuming markets. While the US still remains the largest consumer of oil, it may appear that its domestic energy policy may be hurtful when viewed in the interest of its vast oil-dependent economy.

EMERGING OIL-HUNGRY MARKETS: CHINA AND INDIA?

The oil consumption markets of China and India have matured, thereby exerting great pressure on the declining rates of oil supplies and further driving the prices to an astronomical level for the better part of the current decade. While it may appear that the level of oil consumption is caused by the motive of massive industrial and economic expansion, the results may be that the ultimate winners will be the producers, and sovereign cartels such as the OPEC, which can resort to its age-long tactics of cutting supplies in order to keep the price within a particular threshold. Consequently, there is little reason to wonder that since the $147.00 all-time high price of crude oil in 2008, the price of the commodity appears to have stabilized between $78.00 -$81.00 for several months running now.

A report[4] has it that the US Energy department forecasts that China may burn 14.2 million BPD by 2025 against its current consumption of about 7 million BPD while it’s Asian counterpart, India is expected to consume a more modest 5 million BPD by the year 2020 as against the 1.4 million BPD in 2005. In 2004, China beat a good oil supply deal with Russia for the Re-nationalization of the Yuganskneftegaz, a subsidiary of Yukos but could not secure an equity holding in the company, even though it got a good oil supply deal. One thing that must be mentioned here is that China appears to be more financially buoyant than India, and thus uses this financial muscle to edge out its Asian competitor in major oil deals in the oil producing countries. An example is that of the sale of an Oil block in Angola[5] by Shell Co. in December, 2004 to SINOPEC over ONGC in a fierce bid contest. What inevitably comes to mind of an OPEC analyst is how these emerging market opportunities can be maximized?

ANALYSING OPEC’s IMPACT ON OIL PRICE FLUCTUATIONS

The figure below shows the impact of OPEC’s production through admission of new members on international crude oil prices. From 1960, when OPEC was formed with five member-countries and the subsequent admission of Qatar; Libya and Indonesia; UAE; Algeria; Nigeria and Ecuador in 1972, international oil prices in real terms have been falling drastically.

Fig.4.0                  Middle East, OPEC and Oil Prices 1947-1973 

Source: http://www.wtrg.com/prices.htm.

OPEC’s production and price movement between 1973 and 2009 is shown in Figure 4.1 below. A close look at the picture reveals that whenever production declines, the price of the commodity automatically rises, with the exception of the period of 2007 to 2008 which was occasioned by rise or increased demand of the commodity from countries like India and China, as earlier indicated in the previous chapter. Specifically, there were significant decline in OPEC’s production within the period 1973 -74, 1978-81 and the 1991 Persian-Gulf crisis era. In this period, there were corresponding upward surge in the crude oil prices. The general import of the above is that OPEC’s decision regarding production quotas as a cartel exerts significant and negative impacts on the international price of crude oil.

Fig 4.1:            OPEC Oil Production 1973-2009

Source: http://www.wtrg.com/prices.htm     

Fig 4.2:            OPEC’s oil Production from 1971-2007

  Source: The above graph was constructed myself from IEA 2010 data                                                   

Figure 4.2 above shows the trend of OPEC oil production for the period described above. Generally, there has been a steady rise in the production from OPEC as a group though with noticeable fluctuations over the years with varying proportions e.g. - a 1971 estimated output of almost 48 M/toe of crude oil rose to about 150 M/toe in 1982 and subsequently rose to a much higher output of 250M/toe in 2001.An analogical interpretation of the above may indicate that the new output volume may be inching close to 350 M/toe per annum. 

NUTSHELL

According to Ademola, the issue of defining the culpability of OPEC in determining the international price of oil has found reason in the lessons drawn from the above. This article has examined the issues of oil price fluctuations, the nature of OPEC interventions in this regard and what factors, whether external or orchestrated by the sovereign cartel, do exist in determining the international price of the commodity in issue. He has examined the historical events and factors leading to the formation of OPEC and its eventual formation in 1960- in my previous article; also he traced the history of oil prices and causal effects on the world demand and price of the commodity. While his analysis makes no attempt at value judgments, he feels it is quite clear that the factors leading to upheavals in oil prices in the decades after OPEC have inadvertently been caused more by its members than any other non-OPEC member or events. His paper traced the beginning of post-OPEC price increases and uncertainty.

He concludes on the note that the role of OPEC as a sovereign cartel has to be balanced against the core objectives of the body, but with the interest of the global economy at heart. Ademola suggests there is no rational basis for driving the price of oil to such an extent that the economies of Nations become jeopardized. For instance, he opines that objectives have to be driven by the consideration that cutting production would ultimately lead to more unsatisfied demand, leading to high prices of oil, but an increase in the price of oil could hurt economies thus affecting demand for the product in the long run which oil producers cannot afford.

In my own view, OPEC may have the best chance at ‘influencing’ the Oil Price- by being able to force some short term stability- in the least. Nonetheless, any effort to predict prices on the long term- from analysis- is tantamount to trying to catch the wind. Who’s game? For more information on this article and to view Ademola's professional profile, click here.-->