All Business

BUNK BY THE BARREL

Worried about oil prices? There's nothing to fear but...you know the rest

STEVE MAICH September 27 2004
All Business

BUNK BY THE BARREL

Worried about oil prices? There's nothing to fear but...you know the rest

STEVE MAICH September 27 2004

BUNK BY THE BARREL

All Business

STEVE MAICH

Worried about oil prices? There's nothing to fear but...you know the rest

YOU MAY HAVE NOTICED that it didn’t cost you $200 to fill up your car with gas this week. At last check, buying an airline ticket didn’t require a second mortgage. And this winter you probably won’t have to burn furniture to heat your house. I know, all this may come as a bit of a shock, because in August, when the price of oil shot up to almost US$50 a barrel, headlines were warning that the 1970s were back and a new oil crisis was upon us. The reality is less dramatic, but far more amusing.

Let’s start with the “record high” oil prices you were reading about last month. Actually,

let’s start by forgetting about them, because they were never really record highs at all. Oil hit US$49.40 a barrel on Aug. 20, its highest-ever quoted price. But when you adjust for inflation, it was still far below the US$80 a barrel oil reached in 1979, the height of that decade’s energy crisis.

It’s true, oil rose more than 40 per cent this year. That kind of spike makes people downright jumpy. As always, there were legions of speculators only too happy to stoke the anxiety, spinning tales about catastrophic energy shortages and insatiable demand. Lately they’ve had plenty of fodder to work with. There’s the tragic mess in Iraq, rising demand from China’s burgeoning industrial revolution, Russia’s constant threats to seize control of Yukos, its biggest oil producer. Last week, we heard all about the potential for massive hurricanes to shut down oil rigs in the Gulf of Mexico.

To the speculators, it doesn’t matter that Iraqi oil shipments are relatively stable despite constant harassment from terrorists. They don’t care that Russia has said again and again that it won’t let the troubles at Yukos compromise the country’s oil exports. Even the hurricanes turned out to be a non-issue for the energy industry. But all of that stuff is mere reality. For most of this year, perception has ruled the oil market. This is why analysts have estimated that at its peak, fully $15, or almost a third, of the price of oil was based purely on fear rather than market conditions.

The thing about fear is, it comes and goes. It can subvert the laws of supply and demand for awhile, but market forces always

win out eventually. And what we’re seeing right now are the early stages of fear’s defeat. Last week the price of oil was down 13 per cent from its high. The conflict in Iraq didn’t end. Russia didn’t drop its tax evasion case against Yukos, and China didn’t take a Great Leap Backward. It’s just that the numbers started to come into focus again.

Mind you, not everyone was sucked into believing the sky was falling. BCA Research in Montreal had this to say on Aug. 19, the day before the oil price peaked: “We suspect that prices have been driven beyond a sustainable level by aggressive speculators and industry players who are fearful of a supply crisis.” The research firm called it a “buying panic” and predicted that oil would be heading lower in short order.

BCA nailed that prediction bang on, and the fall isn’t over yet. In fact, many are starting to believe that the real risk facing the energy market is a sudden drop in prices rather than another surge. Last week, the Organization of the Petroleum Exporting Countries raised its production limit by a million barrels a day to reassure everyone the world isn’t running out of oil. OPEC is now producing more oil than at any point in the past 25 years, substantially more than required to meet market demands.

“Remember that speculation cuts both ways,” OPEC warned in its official statement.

DRAWING firm economic conclusions from the short-term gyrations of the oil market is like getting your taxes done by a compulsive liar who can’t count

As soon as the speculators start retreating with their profits, “the crude price could, in turn, spiral down rapidly.”

This sudden turnaround in oil prices is made even more likely by the fact that the Paris-based International Energy Agency has found global stockpiles are actually much bigger than previously thought. Inventories reported in May were understated by about 12 million barrels, and the June figure was understated by another 27 million. But hey, haven’t we all misplaced 39 million barrels of oil at some point in our lives?

All this is more evidence of what analysts have long suspected: the numbers are chronically unreliable, and have tended to overstate the extent of the world’s energy woes. Speculators exploit this uncertainty to create unrealistic spikes in the oil price. Under these conditions, drawing any firm economic conclusions from the short-term gyrations of the oil market is like getting your taxes done by a compulsive liar who can’t count.

According to Merrill Lynch estimates, based on data from the IEA and elsewhere, worldwide demand for oil will rise3.2percent this year, only slightly faster than the three per cent rise in global production. That will still leave us producing 200,000 barrels a day more than we are consuming. How does this translate into a 40 per cent rise in prices? It doesn’t. In fact, those same analysts at Merrill Lynch estimate a barrel of oil will cost US$32.50 on average next year, about 25 per cent less than it did last week.

All the overwrought wailing of late just underscores our tendency to confuse shortterm volatility with a long-term trend. The world is headed for a gradual rise in petroleum prices and a depletion of world reserves over the course of decades. But just like a single cold winter isn’t evidence of a new ice age, spikes in the oil market aren’t harbingers of imminent economic doom, fffl

steve.maich@macleans.rogers.com