How high could crude prices go? Is world in for another oil price shock?
"It's not likely to be pretty -- unless, of course, you happen to own shares in oil and gas companies".
The Globe & Mail, September 6
By Mathew Ingram
How high could crude prices go? That's the question being asked by investors, money managers and commodity traders, not to mention anyone filling up their minivan or sport utility vehicle at the gas pump. At more than $33 (U.S.) a barrel, oil futures are once again bumping up against 10-year highs and all eyes are on OPEC as the cartel meets later this week.
Despite OPEC's commitment to increase production if prices get too high, there are some industry watchers who believe that those 10-year records will soon be a thing of the past and that crude oil prices will soar to the $40- or even $50-a-barrel range. That's oil shock territory and the repercussions could be felt from the gas pump to the White House.
The members of OPEC -- Saudi Arabia, Iran, Iraq, Kuwait, United Arab Emirates, Venezuela, Qatar, Algeria, Libya, Nigeria and Indonesia -- are to meet on Sunday to discuss whether to increase production. Under a "price-band" agreement, the cartel is supposed to boost output by 500,000 barrels a day if the price of a basket of crudes stays over $28 for more than 20 days, which it will likely have done by the time the group meets.
In the world of crude oil, however, perception is almost more important than reality, and there is a perception that a 500,000-barrel hike won't be enough to sop up the demand that still exists in the global oil market, let alone account for the fact that crude inventories in the United States are lower than they have been for almost 25 years.
"We had expected for a while that OPEC would raise its production, but it is not going to be enough," Peter Young, an oil industry analyst with the Royal Bank of Scotland, told Agence France-Presse recently.
How high could prices go? "I don't think we're even close to a top in this market," one energy futures trader said yesterday. "The potential is for this market to go to ridiculous-type numbers -- $50 [a barrel] maybe."
Even OPEC president Ali Rodriguez has reportedly said that he expects crude oil prices will stay high regardless of whether production is boosted by 500,000 barrels after the meeting. "It would be dangerously naive to think today that with a simple increase in production, the problem of stabilizing the oil market will be resolved," Mr. Rodriguez told the Venezuelan daily newspaper El Nacional recently.
One OPEC source told Dow Jones that a one-million-barrel increase is required in order to bring prices back down, while some analysts say an extra 1.5 million barrels is needed -- or three times what OPEC's price-band agreement would produce. Part of the problem with defining the right amount is that the cartel is already producing more than their previously agreed-upon quotas to the tune of about 700,000 barrels.
According to a recent industry survey, OPEC supply in August rose by 670,000 barrels a day to 29 million barrels. Production for the 10 that have quotas (all but Iraq) came in at 26 million or about 720,000 barrels more than the official limit. Saudi Arabia reportedly produced 8.6 million barrels or about 350,000 barrels more than its quota, while the rest of OPEC only managed to produce an extra 80,000 barrels a day.
What all that boils down to is that OPEC oil producers have already cranked their production up to levels not seen for nearly 20 years and prices have still not come down. And the fact is that OPEC is a cartel of one at the moment, with Saudi Arabia the only major producer capable of adding production. To compound the problem, non-OPEC nations such as Mexico don't have the ability to boost their production by much, either.
And the result of all this? If Saudi Arabia doesn't act firmly enough, prices could hit levels not seen since the oil price shock of 1979, when Ayatollah Khomaini overthrew the Shah of Iran and oil markets panicked.
"The risk of an oil price shock is unusually high," Goldman Sachs analyst Bill Dudley wrote in a recent report, saying there was a "10-per-cent probability that oil prices will exceed $50 a barrel within the next year."
A price shock would have more far-reaching effects than just higher prices at the gas pumps. Market watchers point out that a hike in crude could affect Federal Reserve Board chairman Alan Greenspan's decision on whether to raise interest rates. Mr. Greenspan was at the helm 10 years ago when Iraq invaded Kuwait, sending oil prices into the stratosphere and the U.S. economy spiralling into a recession.
Economists say things shouldn't be as bad this time around, because oil now plays a smaller role in the U.S. economy: about 1 per cent in 1999 compared with 2.5 per cent in 1990 and 6.5 per cent in 1979. But it's still not likely to be pretty -- unless, of course, you happen to own shares in oil and gas companies, who will be neck-deep in cash.
Mathew Ingram writes analysis and commentary for globeandmail.com; his column appears on the Web site Monday through Friday.
Readers can send e-mail to mingram@globeandmail.com
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