Oil & gas: how high can prices go? A report researched and written by international economic analyst Moin Siddiqi

Middle East, The, June, 2008 by Moin Siddiqi

While Chakib Khelil, Opec president, told ElMoudjahid, Algeria's government newspaper: "I don't think that an increase in production would help lower prices, because there is a balance between supply/demand and stocks of gasoline in the US have recorded a surplus and are at their highest level for five years". He stressed: "The world economy should not be concerned about the supply of oil--there is plenty available. It should be more concerned about ramifications within the banking system of the effects of the subprime crisis in the US."

Opec has reiterated its commitment to ensure "adequate supplies". Its output capacity should reach 38-40m b/d by 201012 thanks to sizeable investment that also includes the construction of refineries. The secretary-general said: "We are investing to increase capacity. Right now, we have 120 projects worth $160bn just to increase capacity by 5m b/d to 2012." The 13-member cartel is currently pumping about 32m b/d--with spare capacity estimated at 2.7-3.0m b/d (over 80% of which lies in Saudi Arabia). The EIA projects global spare production capacity reaching 4m b/d by end-2009.

Lehman Brothers, the Wall Street bank, broadly agrees with Opec's views on speculative fuelled rallies. "There has been an increase in financial demand as many funds have poured into oil as a hedge against inflation and the weakening US dollar. This has been the main factor in driving the price in recent months. We do not think the fundamentals justify oil at $120 and, without financial demand, we think it would be trading at $20 to $30 below that level." The bank reckons that $40bn of 'hot money' from hedge funds was poured into energy futures over January-April of this year, equal to the entire amount invested in 2007. The latest data from the Commodity Futures Trading Commission (US) showed that speculative net 'long' position (i.e., bets on prices rising) rose by 14.2% to a record 61,954 lots in the week ending 22 April.

Deutsche Bank, too, believes large capital inflows are reflected in today's overvalued markets. "The oil complex is benefiting from fundamentals and money flows. Investors are looking for a place to put their funds where they don't have to worry about subprime. The move above $100 is likely to reverse but selling oil keeps proving to be bad advice." According to PetroStrategies, a Paris-based think tank, speculative trading in crude futures contracts surged from a negligible 0.2% in 2002 to nearly a third of trade in oil by 2006.

How much longer can the global economy remain resilient when the oil price has more than tripled since 2004? So far, demand is proving relatively 'price-inelastic' (i.e., oil usage is still rising), mainly in energy-intensive emerging markets. For example, China's economic output is four and eight times as energy-intensive compared to America and Japan. Also, a lack of viable substitutes to transport fuels means consumers have no other alternatives. The impact on non-oil developing nations like Jordan and Morocco is negative in terms of higher fuel import bills and inflation.