Monday, August 25, 2008

 

A Mexican Review of Oil Prices and US Supply & Demand

 

By Carlos Luken

 

America’s current spectator sports (following escalating oil costs and complaining about gas prices) gave consumers relief during late July and early August; but there are upsetting signs that lead me to consider that this reprieve will be short-lived. The price of a barrel of oil may make a turnaround before year end and reach all-time highs of US$150.00.

 

Unless you’re a conspiracy nut, you will be surprised to know that the price of oil really is fixed by the marketplace. As Economics 101 teaches us, price is the convergence point of supply and demand; in this case the supply in the equation is represented by the oil production chain, while the demand is embodied basically by consumers and speculators.

 

All price fluctuations are caused by shifts in one or the other’s position.

 

First let’s look at the demand side.

 

According to the US Government’s Energy Information Administration July report, Americans guzzle nearly 20.7 million barrels a day, roughly 25% of the world’s consumption. The market’s most recent crude oil price fall, from US$145 (mid-July) to US$113 (August), spurred premature optimism among consumers as national gasoline averages dropped from US$3.88 to US$3.74 last week, definitely  a paltry 0.07% decline however it signaled an important trend reversal.

 

This decline would normally be promising, but it isn’t. While the price drop was caused by lower demand it was not in reaction to higher prices but to a sluggish economy. Consumers are barely making ends meet. 

 

But as gas prices drop, Americans will again follow their traditional ways and forget all energy saving initiatives and return to their gas binge.

 

Also, recent winters have been colder than estimated and brought about higher than projected demands for heating oil causing seasonal price spikes.

 

Oil speculators are following their yearly ritual predicting hurricanes that may severely damage the Gulf of Mexico’s platform infrastructure, disrupting production. Unfortunately on this occasion their grim guesstimates are also fanned by abnormal demand predictions from China and India, and upsetting news from the Middle East and the Caucasus.

 

Besides hurricanes, demand projections and greed, speculators also consider monetary factors. This year’s major concern is the effect a weakening dollar has on the price of oil when used to hedge against inflation

 

Considering the above mentioned factors, the demand side of the oil price structure may tend to increase vigorously.

 

As to what can happen on the supply side is worrisome, I believe. Everything that can disrupt world oil supplies is virtually in the “wrong” hands.

 

According to the same EIA report, the United States produces 25% and imports another 50% of its crude oil consumption, and more than half of the imports (6 million barrels/day) come from “The friendly folks who brought you oil shortages," i.e. OPEC.

 

Although the cartel is not evidently run by anti-Americans countries like Venezuela, Iran or Saudi Arabia, it is controlled by greedy nations; whether they love or hate the US, they all love its dollars. It’s no coincidence that all important crude oil price increases that have occurred since 1973 have been sparked by Middle Eastern crises or by OPEC manipulations.

 

OPEC’s economic policy is very simple. Lower production and the market will raise prices. Whenever consumers have problems filling their tanks, OPEC nations effortlessly fill their coffers.

 

Unless you have been sniffing too much gasoline vapor, there is no evidence to support the notion that the cartel will increase its crude production in order to lower prices.

 

Regrettably non-OPEC suppliers are too small, corrupt or unreliable to have market influence.

 

Then there is the war between western allies versus Muslim extremism. Shiites, Sunnis, Kurds, even Taliban, have strong followings in all Muslim nations. There is tremendous pressure on governments to create disorder or harbor and finance terrorists. The region is a powder keg with a lit fuse. One nation or even a breakaway group can disrupt production and block the principal oil sea lanes. Just observe this month’s attack in Eastern Turkey by a band of Kurdish rebels on the Baku-Tbilisi pipeline that paralyzed the flow of almost 900,000 barrels a day to the west. Distribution interruptions like these are also cause for grave concern.

 

An additional menacing occurrence pressuring oil prices volatility is the recent awakening from hibernation of the Russian Bear.

 

In one week, four of the six Baku based pipelines that are crucial to the West’s oil flow were in harm's way, and all six are now virtually under Russian control. Russia’s craving to restore itself as the powerful USSR has allowed Vladimir Putin to indulge in saber rattling and indict NATO’s interference in what they now consider to be Russia’s sphere of influence. With the US and NATO seemingly hesitant, there is concern that Moscow hardliners running the country may take action to seek a Russian-Arabic alliance to strangle the west.

 

Another important concern that is being factored into the equation is the US election. There are clearly two diametrically opposed candidates. Although suppliers tend to gain under a non-responsive US presidency, they can lose if the opposite becomes a reality. Timing is of the essence if anybody is going to make bold moves, which will have to be made and consolidated before the November election.

 

I personally do not think that a suitable combination can occur; in fact the opposite seems to be happening already. A US$150 barrel in November may sound crazy, but it may also be cheap by the first quarter of 2009. I hope I’m wrong, but what worries me most is that hope is all we have.

 

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Carlos Luken is a Mexico-based businessman and consultant.