Oil Prices: Why so High?
A Look at the Many Factors Causing the Rise in the Price of Oil
Crude oil prices are climbing higher and higher, with oil futures trading at record-breaking levels at the New York Mercantile Exchange of $130 per barrel (per bbl). Anxiety about higher gasoline prices at the pump has generated a blame game in the media and among politicians, yet there are many complex reasons for today's high oil prices.
Growing Demand from Developing Economies
Over the last decade oil demand growth has accelerated in major developing economies in Asia, especially China and India. Economic growth has meant rising oil consumption as demand for vehicles has increased. Much of the growth in global oil demand over the last decade has come from outside the OECD: especially from China.
Geopolitical Factors
There may be hundreds of billions of barrels of oil in the ground, but many oil producers are blighted with political risk which has curbed potential output growth. Production in Iraq has struggled to reach pre-invasion levels because of insurgent attacks on pipelines and oil facilities; investment in Iran’s oil has been slowed by the risks associated with the standoff over Tehran’s nuclear program; civil strife in Nigeria’s oil-producing regions has caused stoppages in exports. Oil market fears of instability in the Middle East and elsewhere have added a risk premium to prices.
Tight Opec Spare Capacity
With Opec producers supplying oil-hungry Asian markets the group’s spare capacity has been reduced to historically low levels in terms of a proportion of total global supply. This makes oil markets more nervous about the multitude of risk factors that plague oil-producing regions. Markets fear that Saudi Arabia and other producers don’t have enough oil in reserve to compensate for a sudden shortfall in supply caused by a conflict, a major terrorist attack or some other crisis.
Non-Opec supply Growth Worries
There are concerns that non-Opec producers are beginning to see output declines in major oil fields, with Mexico, the North Sea region and now Russia major cases in point. These fears will not be allayed by preliminary analysis from the International Energy Agency which has raised concern about the ability of oil producers to continue keeping up with the incremental increase in global oil demand.
Weakness of the US Dollar
Crude oil is priced in US dollars and that currency’s current weakness has placed upward pressure on commodities such as oil that are denominated in the dollar. Furthermore, oil exporters worry about the real value of their export dollars, and thus are less inclined to act towards drastically reversing the steady rise in prices by boosting output.
Investment in Commodities
Mediocre performance in equity markets and the US dollar’s weakness have facilitated hedge and pension fund investment flows in to the commodities sector, including crude oil. For some commentators speculative trading has literally added “fuel to the fire” of rising oil prices.
Absent a global economic downturn and a massive boost in investment to increase the productive capacity of oil exporting countries, high oil prices will likely be around for some time. Even if the cyclical nature of commodity markets takes affect and prices drop we will probably see a higher price floor than we have in the past.
