How global demand adjusted to oil prices

Font Size

Print

Feedback

Email

Discuss

: It is just two years and some months back that crude prices crossed the $40 per barrel (/bbl) mark. A perceptive industry analyst (Purvin Barrow, July 2004) had focused on the two ‘engines’ of demand growth—the US and Chinese transportation sectors—and the severe supply side squeeze with spare Opec capacity dropping sharply and inadequate new asset creation by oil companies in the environment of low oil prices characterising the second half of the previous decade. The conclusion was that if everything came out wrong—the ‘train wreck’ scenario, crude prices would rise to nearly $90/bbl in 2006 and gradually fall over the next few years. The moderate picture of ‘controlled’ shortfalls would see prices rise steadily to $55/bbl by 2006, with the up trend continuing to $60/bbl in 2007.

Well, we did not quite get to $90/bbl, but it was hardly a train wreck. The world economy has been growing well above the trend rate and despite high petroleum product prices, general inflation has been in control. Basically oil prices reached the level they did because the world economy was able to afford it. Some hundred years ago, Sir Marcus Samuel, founder of the Shell Transport & Trading Company, British half of the later Royal Dutch Shell, quizzed by a statutory committee investigating allegations of price gouging, responded, “price of oil, gentlemen, is what the market can bear.”

But in bearing those high prices, fairly straight forward adjustment is put into motion. The rate of increase in demand slows down and investors pile on investment to expand production—and eventually prices tend to soften towards the level needed to sustain the more expensive component of production, while the low-cost producers, mostly Opec, take in rents.

However, most markets, unlike novelists, tend to expect the mundane—a series of tomorrows not wildly different from today. To go from below $30/bbl to over $70/bbl needs some high-powered rocket fuel, which can only come from a big shock. In 1973 and 1979, the shock was political; first the embargo on oil exports by Arab nations (followed by nationalisation and Opec’s coming of age) and then by the outbreak of the Iran-Iraq war.