Not So Nice About Oil

Last week I gave a lecture in Paris at the Université de Paris (Dauphine), in which I did my usual best to explain to a group of energy economics students that OPEC had now taken command of the oil price.

Fortunately, the director of that establishment, Professor Jean-Marie Chevalier, had no problem with my contention, because as almost everyone now understands, when the present macroeconomic malaise blows over, OPEC will likely make a move to increase its already impressive income by a few more dollars a day, since the OPEC "hawks" are apparently dissatisfied with the present price.

According to OPEC's October report, world oil production reached 85.8 mb/d during the third quarter of this year, of which OPEC's share (in September) was 33.7 percent. Working with an average price of 77 dollars per barrel (= $77/b), OPEC's  (gross) revenues came to a cool 2.226 billion dollars a day.

I can remember when anyone even thinking that OPEC would someday be  involved with that kind of money would keep his thoughts to himself. But now, of course, the sky is the limit. Chinese demand continues to move upward, and according to McGraw-Hill's information arm, the Chinese demand reached 8.45 mb/d in April (of this year), which was almost 13 percent above the demand of that country a year earlier.

What will happen to price if this kind of demand growth continues is difficult to say, although according to my way of viewing the issue, it won't be anything nice for those of us on the buy side of the global oil market. The next oil price escalation is going to begin at $75-85/b, which is an event that it would wonderful to avoid.

Everyone doesn't believe however that the situation is as serious as I like to claim. For example, Sandrine Torstad, who is in charge of analysis for (Norway*s) Statoil, believes that the present large inventories of oil will have to be decreased before the price goes on a rampage. I put my usual diagram and mathematics on the whiteboard at Dauphine to explain why normally this was good reasoning, but I made it clear that I am no longer certain that  my logic makes as much sense today as it did when earlier. OPEC's position has simply become too strong.

At the end of 2008, with the oil price going into the can, OPEC began a production-decrease program of 4.22 mb/d that resulted in certain highly paid oil experts once again seeing their predictions turn sour. What happened was that the oil price began a climb that - on the basis of what was happening  in the world macroeconomy and financial markets - should not have taken place. That climb culminated with the oil price at about $70/b, and the last time I looked it was over $80/b.

The Secretary-General of OPEC, Abdallah Salem El Badri, recently said that "the emergence of oil as a financial asset, traded through a diversity of instruments in futures exchanges and over-the-counter markets, may have helped fuel excessive speculation to drive price movements and stir up volatility"(2010). I had been lecturing in Paris for almost two hours when I got around to that subject, and had a slight problem remembering what I had spelled out in detail  in the long paper on which this note is based, but even so I had enough steam left to insist that unlike the U.S. Rangers, the oil futures markets follow rather than 'lead the way'.

At the same time I made it clear to those young students that if I were in the place of Mr El Badri, I would have said exactly the same thing. After all, that gentleman does not work for the governments of North America, nor the careerists directing the European Union, nor the Association of Good Housekeepers that I used to occasionally hear about when I was a boy in the United States.  If the television audiences want to believe that OPEC countries prefer less money to the long green now pouring in, and therefore - as the Secretary-General claimed - will join the oil importing countries in keeping the oil price from 'breaking' $150/b again, then as far as I am concerned, they deserve what they will get.

By. Ferdinand E. Banks

REFERENCES

Banks, Ferdinand E. (2010). Oil and Economic Theory: Some Chronological and
        Mathematical Aspects. The Swedish Journal of Economics (Forthcoming).
Höök, Mikael (2010). Coal and Oil: the Dark Monarchs of Global Energy. Uppsala:
        Universitetstryckeriet.
Sarkis, N. (2003). 'Les previsions et les fictions'. Medenergie (No. 5).
Smith, Pamela Ann (2010). 'Will oil break the $150 barrer barrier? The Middle East
         (August/September)