VHeadline.com oil industry commentarist Andrew McKillop writes: Underlying the daily testing of a so-called ‘ultimate ceiling price’, of US$40 per barrel of WTI, is the market fundamental of world oil demand. To date, and in fact since the end of Cheap Oil was presaged and announced by the 1998-99 tripling of oil prices, world oil demand shows no ‘price elastic’ response to higher prices.

In fact, the ‘reverse elastic’ relation of oil prices to world oil demand is being proved every day: as oil prices move up, so does world oil demand. No ‘price elastic’ fall in oil demand due to higher prices is likely until and unless prices go far beyond $40/bbl, and attain price levels comparable in real terms to those of the ultimate recent historical peak, in 1979-80.

At the time, due to Iranian oil supply cut-off caused by the Iranian Revolution, and the ‘geopolitical uncertainty’ produced by US political writ no longer having any hold at all on Iran (today:Iraq), oil prices were bid up to around $40-45/barrel, in 1979 dollars.

In dollars of 2004 that oil price is well above $110-per-barrel. The current oil price, even when it reaches the $45-50/bbl region, driven by the complete loss of all credibility by the Bush and Blair regimes in their so-called ‘liberation’ of Iraq, is far lower than that needed to induce ‘price elastic’ falls in demand. We are in fact moving into the ‘overdrive’ zone for world demand growth — able now to break far out of the 1.3%-1.6%/year region that held in the ‘cheap oil 90s’, and attain the 2.25-2.75%/year range.

One interesting energy economic fact is the following: in 1979, before slugging interest rate hikes into double-digit extremes were first applied in Thatcher’s UK, then Reagan’s USA to strangle economic growth and trigger full and intense economic recession, world oil demand was increasing at a yearly rate of about 4.5%. Expressed in dollars of 2004, the second Oil Shock of 1979-81, through pushing oil prices into the $60-90/bbl range, reinforced already strong growth trends for world oil demand. Only extreme interest rates brought down oil demand – through destroying economic growth, bankrupting companies, and dumping millions of persons into joblessness.

Nothing has changed relative to that macroeconomic context: much higher oil prices will trigger much higher oil demand, until and unless slugging interest rates are applied to destroy enterprises and create mass unemployment in the so-called ‘democracies’ of the richer OECD nations, led by the USA. The major and critical difference, today, concerns the simple fact of Peak Oil. Iraq invasion was only an ‘option’ in 2000-2001 when the Bush war cabinet sought to create or find the pretext for first invading Afghanistan, then Iraq.

* Oil from Iraq was at the time in no way critical to market supply and the supply/demand balance for world traded oil. This is no longer the case.

By 2005-2006 every drop that Iraq can be made — or persuaded by higher prices — to produce will be needed to prevent ‘structural supply shortfall’ from emerging on world oil markets. Whatever Saudi princes with an option on Bush re-election may wish to pump, to make up for missing supply, will soon be way out of their capacity and scope.

By 2007 at latest, any Saudi princes that might remain in power will have had their pumping capacity bluff called many times over! Under almost no rational scenario can or will Saudi Arabia raise production beyond about 10.75 Mbd (slightly more than today’s peak rate), exactly like Iraq will unlikely ever exceed its early 1980s peak production of about 3.75 Mbd.

World demand is now on a growth trend of above 1.8 Mbd each year, and world oil import demand is likely close to one-and-a-half times that rate, that is well above 2.5 Mbd/year. This is due to failing oil production in many large importer nations, led by the USA but now also including China, India, and the European Union which, in the next 6 years, will increase its oil import demand (unless heroic and painful demand cuts are made) by at least 5 to 6 Mbd.

Nothing that Saudi ARAMCO or any Russian oil oligarch can do will change or oppose this trend to ever-intensifying ‘tightness’ of market supply, and both Saudi Arabia and Russia can surely use the petrodollar and petro-euro bonanza that is coming!