Oil prices

Why global oil prices are rising?

Oil is a major source of energy the world over. When energy (read oil) is available at low prices, the outlook towards growth is optimistic and vice versa. Crude oil prices have been rising continuously since 1998, when the price was $10 a barrel.

Since the death of the King Fahd of Saudi Arabia on August 3, crude oil prices have crossed $60 a barrel. Recently, crude prices crossed $70 a barrel as the hurricane Katrina hit the United States and brought production in the Gulf of Mexico to a halt.

All this has led to talk of sustained high prices in the days to come. But, as history tells us, oil is a cyclical business: prices go up only to come down again. So the question that needs to be asked is: why have oil prices been going up and will this increase continue in the days to come?

There are several reasons to account for the rising oil prices.

The oil cartel

Since the mid-eighties, the Organisation of Petroleum Exporting Countries (OPEC) has been acting as a swing oil producer of the world. That is, OPEC produces only to fill the gap between global oil demand and production by non-OPEC countries.

Over the years, the swing production arrangement resulted in OPEC having a lot of idle capacity. This helped OPEC to gain control over oil prices. Whenever the inventory level of oil stocks in industrialised nations, particularly the members of Organization of Economic Cooperation and Development (OECD) went up, OPEC reduced output.

This artificial scarcity that OPEC manages to create did not allow oil prices to fall.

The same idle capacity has been used to pump extra oil into the market to prevent dramatic price rises during times of unexpected supply interventions. Most of this idle capacity is in Saudi Arabia, the largest member within OPEC.

The country has effectively used its idle capacity in the past to prevent any price increase during the Iran-Iraq war, the Gulf War and the recent Venezuelan crisis.

But that situation seems to be changing now, with OPEC unable to control the surging global oil prices. OPEC members have been pumping oil as fast as they can with hardly any idle capacity left. Saudi Arabia is the only country that has some spare capacity left. The idle capacity stands at just 0.5 million barrels per day (mbpd) as against 3 mbpd few years back.

So even though there is no shortage of crude oil, the fact that there is no safety net, has made the oil traders jittery. This has led to them demanding a risk premium and so the high price.

There are also other reasons which include political instability in the oil-rich countries for example, the middle-east countries, as well as the increased global demand over the recent years. Global consumption of oil went up by 3.4% last year. The consumption of oil in the United States remains the biggest reason for this sustained growth in the global oil demand. The US, which has just 5% of the world population, consumes one quarter of the global produce. The oil efficiency of vehicles in the US has now fallen to a 20-year low. Its energy policy does very little to ensure greater fuel economy in cars or sports utility vehicles.

-Yiming