Tuesday, November 20, 2007

Sher Value: Oil to score a century!

Crude oil prices will, most probably, breach the $100 per barrel mark, and perhaps by an easier stride from the mid nineties where it stands perched today. However, there is more to the issue of oil prices than just watching it in the nervous nineties, its perhaps the most fabulous story on commodities. Between 1999 and 2006 the price of oil moved from $10 to $60, and between 2006 and now, the end of 2007 it has moved from $60 to $96, and for once none of these increases can be blamed on the OPEC or any political or economic maneuvering of the oil cartel. To put this rise in perspective assume a country exporting 2 million barrels of oil a day in 1999 was earning US$20 million per day, and today the same country is earning US$192 million per day!

To understand this phenomenal rise we have to look at the massive demand for energy that growth in India and China have been witnessing. China’s demand for oil has more than tripled in these seven odd years. There is little evidence that this global demand will slow down and a world recession, while possible, will have to be quite severe to bring this engine to a halt.

As OPEC ministers meet in Saudi Arabia it is not only clear that an output increase is not on the cards but surprisingly some members are arguing that perhaps it is time to dump the dollar as the reference pricing currency. While a continued fall in the greenback value will hurt the purchasing power of oil earnings, and the market will price in ‘compensatory increases’ for the price of oil. This is partially responsible for the recent up ticks as oil inches towards the 100 mark.

However, the price of oil is not only about demand and supply, but also is related to future demand and future supply. As demand has been growing we have to remember that oil reserves are growing at less that .75% per year. In the past two decades new reserves have been discovered at the rate of about 3% per year. What this means is that if oil demand has grown by an average of 12% a year over the past decade then new reserves have only been created at one fourth that level clearly implying that into the future there will be serious supply constraints. While high oil prices will spur on new oil explorations, the cycle of discovery to actual oil production does take a few years to achieve.

Long term economic modeling will suggest that a recession on a world wide scale may perhaps be the best thing to calm things down, the simple truth is that the engines that are pumping away in the emerging markets, and consumer led demand will be hard to reign in. The US was consuming 16 million barrels a day in the 1970’s and today its consuming 22 million barrels but the growth has been elsewhere. Try and imagine if every Chinese and Indian move to own an automobile, scary thought right?

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