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Oil may cross $112

Oil may cross $112 in a year

8.11, 2007

Last week, oil prices sizzled up to over $90 a barrel. What was amazing was the speed. It took just six days for prices to rise 10 per cent.

The present round in price rise had been taking place since the middle of September after the OPEC meeting in Vienna. Prices at that time were about $75 a barrel and were considered excessive.

The OPEC had then agreed to increase production by another 500,000 barrels a day. But from the day of the meeting itself prices began to crawl up until last week when they actually galloped.

The immediate cause was the threat of the Turkish military campaign in Northern Iraq within the missile range of Kirkuk, Iraq's first oil site. This gave vent to speculation that drove prices up. Besides, with the cut in the interest rate by US Federal Reserve on September 18, the dollar had depreciated. If the euro were taken as the reference currency, the weaker dollar would have been responsible for nearly a fourth of the actual rise in oil prices since September.

The OPEC too is concerned about the high prices but believes that the rise is not because of any change in the fundamentals. There was, therefore, no need to increase supplies beyond the already agreed 500,000 bpd from November1. OPEC nevertheless accepts that demand for oil is higher than what it had anticipated possibly because the US economy did not go into recession.

The Turkish intrusion into Iraq was delayed and oil prices retreated temporarily to head back again towards the earlier peak. US sweet light crude was selling spot at over $88. It needs to be recognised, however, that oil prices have risen at less than the general rise in prices. Adjusted for inflation, the price of oil equivalent to the actual price in early eighties would have been $101 a barrel today. What hurts is that 90 per cent of the price rise came only in the last 10 years.

In future, the oil market is likely to be exposed to occasional crisis. First, the spare capacity with OPEC members is less than 2 mbd, against the present world supply of 86 mbd. As such OPEC would be reluctant to accommodate short-term fluctuations in demand. Second, the non-OPEC producers are capacity bound and cannot increase production significantly.

The demand pressure on the oil market will continue and prices will rise. Fortunately, unlike in the seventies, countries are prepared to accommodate the price rise without forcing the economies into recession.

It is unlikely that the fast growing, oil importing, transitional economies like China and India and slow moving oil guzzlers like the US will be able to restrain demand. The expectation therefore is that oil prices will cross $112 a barrel within a year.



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