History repeats itself: food riots are breaking out across the poorer nations, the Middle East is in turmoil and Brent crude has passed the $100 mark – 2011 is opening just like 2008 did.
It was a significant year in terms of the global economy: social unrest around the world over a spike in the cost of staple foods, and the runaway price of oil that eventually triggered the worst global economic crash since the Great Depression. While there were undoubtedly other factors behind the downturn, 2008 stands as a benchmark in terms of oil and economics – a shorthand for high oil prices and economic turmoil. We don’t want another 2008, especially with the faltering recovery that has yet to turn substantive cash injections into jobs.
Now, it may be just coincidence, but it looks suspiciously like the issues that shaped the first half of 2008 are back: oil demand is surging, its price is rising, and people in the poorer nations are consequently finding the cost of staple foods out of reach. There is a direct link between the cost of oil and food – which I’ll return to in a subsequent post – and so the first to suffer from a rise in oil prices are people in developing countries living on a couple of dollars a day who cannot absorb rising costs.
If the cost of oil goes on rising – and all indicators suggest it will – then we will see a growing humanitarian disaster around the globe. Neither are our industrial economies immune: based on the assumption that $150-per-barrel oil breaks the machine, how much space do we have before we see oil prices triggering another global recession?
First, a flashback to 2008 is in order. The year opened with food riots which gathered momentum in the first half of the year. There were riots in India, Burkina Faso, Cameroon, Senegal, Mauritania, Cote d’Ivoire, Egypt, Yemen, Morocco, Haiti, Senegal and Somalia. Varying levels of unrest were also reported in Mexico, Bolivia, Uzbekistan, Bangladesh, Pakistan, Sri Lanka and South Africa.
The International Energy Agency (IEA) website archives monthly oil market reports, so we can see that oil began the year on a high, crossing the psychological $100 barrier, and projected global demand for oil rising:
NYMEX light sweet crude futures breached $100/bbl in early January and remain near record highs, lifted by falling stocks, cold weather and tight fundamentals. Tensions in Nigeria and the Middle East and fund positioning remain important supportive factors.
2007 world oil demand is revised up by 150 kb/d to 85.8 mb/d on stronger-than-expected deliveries in Asia and the Middle East and cold OECD weather.
You can follow the surging prices through the first half of 2008, each month setting a new record: $105 per barrel by early March, $110 in April, $126 in May, around $140 in June (“following comments by an Israeli official that an attack on Iranian nuclear facilities was ‘inevitable’ and. . . against a tight supply background with no clear sign of the usual second-quarter crude oil stockbuild”) to an early July peak just above $145 per barrel. Then came the recessionary fall from $147 a barrel in July to $32 in December. (It was back up to $85 within five months, despite the global economic collapse.)
Now, jump forward to 2011. The year opened with the UN announcing that food prices“surged to a new historic peak in January, for the seventh consecutive month,” and further price increases could trigger upheaval and riots in developing countries. We have already seen protests over food prices in Niger, Guinea, Burkina Faso, Mexico, Tunisia and Yemen this year. Protests linked to prices of staple foods are currently sweeping across the Middle East: Bahrain, Libya, Yemen, Iran, Iraq and Egypt are aflame.
Now, oil: the IEA’s Oil Market Report for January 2011, published February 10, shows Brent crude reaching the psychological $100 barrier and demand increasing:
Crude prices were propelled higher at end-January by political unrest in Egypt, with Brent crude reaching $100/bbl on fears that the turmoil might disrupt Suez canal and SUMED pipeline flows or spread in the region. Although prices have since eased, Brent futures remain around $100.50/bbl and WTI [West Texas Intermediate] at $87.20/bbl at writing.
Global oil product demand for 2010 and 2011 is revised up by 120 kb/d on average on higher-than-expected submissions in non OECD Asia and improved economic prospects for OECD North America. At 87.8 mb/d in 2010, global oil demand rose by 2.8 mb/d year-on-year, and should reach 89.3 mb/d in 2011 (+1.5 mb/d year on-year).
World oil supply rose 0.5 mb/d in January, to 88.5 mb/d, on higher OPEC crude and NGL output.
(Canadian oilsands output is already flooding parts of the US market, driving down West Texas Intermediate crude oil prices, while Brent is now more of a bellwether for international price trends.)
So, according to the IEA, global demand for oil is set to reach 89.3 million barrels per day in 2011; supply is stated at 88.5 million barrels per day, with Opec effective spare capacity – its ability to open the spigots and produce more at a moment’s notice – offering an additional 4.7 million barrels per day.
The assumption, then is for another year of tight oil supply, with Opec’s spare capacity dwindling – possibly as low as 3 mb/d.
Looking back over the IEA reports for 2008 we see some interesting price-related snippets, from “falling stocks, cold weather and tight fundamentals” in January to the fear of an imminent attack on Iran and observation of low Opec spare capacity (“Higher output and field commissioning delays push [Opec’s] effective spare capacity below 2 mb/d”) in June’s report.
So, we are starting 2011 with high demand after a particularly cold winter in Europe, turmoil and revolution across the Middle East including agitation from Iran which might or might not be sending two warships through the Suez Canal, and speculation of Opec spare capacity dropping low despite their subsequent investment.
Back in 2008 Opec – and many Western commentators – pinned the blame for runaway prices squarely on the shoulders of commodity speculators. Speculators are in the news at the moment, being blamed by both the UN and the European Union for pushing up food prices and setting the stage for a humanitarian disaster across the developing world. It leads to the question: do speculators have that much influence over the market for oil, or are they a handy scapegoat?
When interviewed in June 2008, billionaire investor Warren Buffet said supply and demand, not speculation, was driving oil to record heights. As reported by USA Today:
Buffett said he disagrees with the idea that speculation was driving oil prices higher. At least nine bills proposing limits on that oil speculation have been introduced in Congress in recent weeks.
"In my adult lifetime, up until the last year or two, there's been a huge amount of excess supply available," Buffett said. "We don't have excess capacity in the world anymore, and that's why you're seeing these oil prices."
A Wall Street Journal item from July that year, Restricting Speculators Will Not Reduce Oil Prices, considered “wild assertions” of commodity price manipulation that were “completely unsupported by reliable evidence.” It states:
For the most part, speculators do not demand physical oil the way thirsty Chinese refiners do. There is no evidence that speculators are accumulating large and rising inventories of physical oil. But to cause prices to be above their competitive level, speculators would have to take physical oil off the market -- the way that governments have done in the past with agricultural products, amassing mountains of grain and cheese to prop up their prices.
The role of the futures market in oil is explained in an item, Oil Politics and Commodities Speculation: Myth and Fact, again from July 2008, which explains the nature of speculation:
Oil refineries like Exxon-Mobil or Shell or British Petroleum must ensure that they have a supply of crude oil for their refineries, not just for today, but for next month, next quarter, next year. Similarly, an auto manufacturer or a farm both depend upon fuel oil and other commodities and also have the choice of buying them on the spot market or the futures market.
Think now of supply and demand. The commercial business entities which truly need the commodities represent one portion of the market and make up a good deal of the demand. Another part of the demand is made up of people who need to make profit for themselves and their investors. They see an opportunity in rising oil prices and decide to guess that the upward trend in price will continue. They bought 100,000 barrels of oil two months ago at $120.00 per bbl. and can sell it today for $135.00 per bbl. These speculators make up another portion of the "demand" segment. The unusual thing about oil or any other commodity is that most speculators never take delivery on the commodity; they merely trade and cash in on the paper contract backing the commodity. Yet, they have become a large part of the demand market.
This concludes that investors are drawn to a market with rising prices – “speculation is fueled by market fundamentals” – and may in turn push the price higher – “the farmer and the manufacturer must compete with these speculators to buy fuel, accounting for higher prices” – but the oil “profit bubble” has more to do with demand from India and China, government policy and the claims of peak oil hyping everything up.
(Of course, many media outlets took a different route, squarely blaming Chicago and New York mercantile exchanges – NYMEX pictured, left.)
Blame who you want, but the price of oil relates to supply and demand. Speculators may push the price upwards - and last year a Reuters industry poll suggested they were raising the price by $10 to $30 a barrel - but clearly are not drawn to a buyer’s market. When hedge funds ride in to place their money in oil, it can only mean that the oil market is superheating. They are adding extra dollars to the cost of a barrel, but are not wholly to blame.
The problem lies in our expectation that a finite resource can be extracted at an exponential rate.
The IEA’s World Energy Outlook 2010, published late last year, included the suggestion that oil demand, excluding biofuels, will continue to “grow steadily, reaching about 99 million barrels per day (mb/d) by 2035 — 15 mb/d higher than in 2009.” (The document hedges its bets by talking in terms of various scenarios; one suggests demand for oil could fall away a little ahead of 2020.)
Over the past five years, China has spent more than US $713 billion on a 46,000-mile road expressway system that’s just a little short of the US interstate system. It’s hard to imagine these roads not in use over the coming years.
China, the most populous country in the world, has the world’s fastest growing major economy, becoming the world’s largest exporter, second largest economy and largest energy consumer in 2010. The US still has the world’s largest economy and one of the world’s highest GDP per capita, but it’s China that is driving global markets, maintaining high global prices for raw materials and energy imports through the level of its demand, and rewriting the geopolitical order in its attempts to guarantee future oil and gas supplies. China is leading the charge for more and more oil.
There are a couple of differences between now and 2008 – essentially the output of Iraq (expected to reach 2.75 million barrels a day) and Canada, which is set to show an increase of between two and seven per cent and is already pushing down West Texas Intermediate crude oil prices - but not Brent. But when all is said and done, the same big picture factors are in place – voracious demand, market jitters about the ability of the oil producers in a strife-torn region to deliver and a price feedback loop due to commodity trading.
Believing that prices will rise is a matter of market fundamentals, and does not require one to believe in peak oil, the notion that the world will reach a time of maximum output for geological reasons – although many suggest that the world is at or around its production limits, with oil producers regularly lying about reserves. I happen to believe the world cannot go on increasing oil output year after year, and that we will very soon see peak oil hypothesis become an accepted scientific fact. Even if doesn't happen this year, I think we’re still in for a bumpy ride.