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Oil Price Hike: Reasons and Impacts

Oil prices soared to historical record levels approaching $ 50a barrel two weeks ago, after ranging at about $ 10five years ago. Of course when oil prices go up or down sharply, the number of writers who seek to analyze the market situation and who claim to know all its aspects and secrets will increase. There is no doubt that the current surge in prices was unexpected, as most, if not all forecasts by experts, consultancy firms, energy organizations and companies at the beginning of this year were not expecting that prices would reach even $ 35per barrel. In fact they were predicting just the opposite but what happened was the contrary as a result of some oil and non-oil developments simultaneously and successively. The most important ones of these developments are:

First: The increase of world demand was more than expected, particularly in the United States, China and India and some developing countries. The International Energy Agency predicted at the beginning of this year that the world demand for oil this year would be less than 80 million barrels a day, but it later adjusted its forecast to82 . 2million barrels a day (bpd), with an increase of more than two million bpd.

Second: At the beginning of the year, analyses indicated that new quantities of oil would enter the international market, particularly from Russia, Caspian Sea, West Africa, Iraq and others, but this did not happen in the expected quantities.

Third: The political and labor situations in some oil exporting countries, as political and security instability and the fear of chaos or security problems affected production of these countries such as Iraq, Nigeria, Venezuela and Saudi Arabia. Apart from that the labor strike in Norway and the problems of Yukos oil company in Russia also contributed to creating a state of panic in oil markets, especially with the limited surplus of world oil production capacity, which is currently estimated at about1 . 5million bpd (about one percent of the international market demand).

Fourth: The pressures on the oil products market, particularly in the US, which consumes a quarter of the international production. In the US market, there are problems associated with oil refining and the quality of used oil products. These problems result from the regulations that have affected the establishment of new oil refineries. (Industrialized countries have refining capacities equal to or exceeding the market demand with the exception of the US which has a shortage of up to two million bpd or 10 percent of its needs, and the shortage is met by importing oil that may not always be available at the required standard). These regulations make it difficult sometimes to meet the demands of some US states, thus causing a shortage in the inventory of oil products.

Fifth: The situation of financial markets, for there is an important role being played by the international financial market on the world oil market. This mainly takes place through the investment funds and speculators in the future oil market, who contribute to the rise or decline of prices as per their view of the oil market on one hand and the investment opportunities in the different financial channels on the other hand. The decline of interest rates on many of the main currencies, fluctuations in the stock market together with a decline in dollar value and increase in the demand for raw materials pushed some investors in the future market to sign contracts for the purchase of row materials, particularly oil contracts, a matter which has remarkably contributed to the rise in oil prices.

There is no doubt that the oil consuming countries — industrialized as well as developing ones — have the ability to cut their dependence on oil particularly when it becomes clear that the price rise is due to deliberate action by the producing countries and that may affect negatively their economies. They can adopt policies that will lead to the reduction of their oil consumption particularly at the medium and long terms, and this, for its part, will affect the income and situation of the main oil producing countries. The effective policies taken by consuming countries, particularly in the previous oil rise periods, such as hiking tax on oil products and encouragement of the use of other alternatives and enhancing efficiency of the use of oil and energy. Those policies proved successful not only in reducing oil consumption but also slashing oil demand. The same thing is applicable to several other industrialized consuming countries. A visitor to Holland today will notice high rate of the use of cycles as a result of a policy encouraged by the government 30 years ago, with the aim of reducing oil imports. The industrialized countries have succeeded in this matter in the previous years, and this success is not limited to the slowdown in the growth of oil demand and shrinking of the positive relationship between economic and oil demand growth. It also led to the increase of production in new areas, as the demand for OPEC oil declined from 31 million bpd in 1979 to 15 million bpd in 1985, i.e. more than half, while the production of Saudi Arabia declined from more than 10 million bpd in 1980 to about three million bpd in1985 .

What may lessen the impact of the current crisis and make it different from the previous crises is that most people are aware that the current oil price hike is attributed to several factors, none of them dominant, and it is not an issue of conflict between producing and consuming countries nor has it come about as a result of deliberate actions by producers.

The main challenge facing the Kingdom is non-dependence on one commodity — despite of its importance and price — as a single source of national economy with all its dimensions (state budget, balance of payments and gross domestic product), particularly when this commodity is liable to great fluctuation not only in its prices but also in its production. Thus comes the importance of the Kingdom’s efforts to stabilize international oil market not only in terms of prices but also in terms of balancing demand and supply. It also works to ensure adequate supply and establish close cooperation with oil producing and consuming countries.

This leads us to talk about current prices and the possibility of their remaining high. Talking about the possibility of the continuation of prices at the current level or around it is doubtful especially in the medium term, because market principles are not based on such an assumption.

Before concluding this article, I would like to mention that we live in an international market where the interests of all its parties are interrelated and affected by one another. When oil prices increase, they will have negative impacts on the international economy. When the international economy shrinks, the oil demand will decline and vice versa, i.e. when the international economy grows, the demand for oil also grows.

The trade logic compel producers to concentrate on their present and future interests, most importantly taking care of end consumers and not to enter into conflicts with others as this may lead to opposite results on the long run. We, as oil producers, should not resort to political assumptions like talking about conspiracy or about assumed political dimensions not supported by known facts as they may keep us away from the economic and technical facts of an important industry and trade like oil.

(Dr. Ibrahim ibn Abdul Aziz Al Muhanna is an adviser in the Ministry of Oil and Mineral Resources.)

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