What’s driving the price of oil?

  • What is it with the seemingly endless instability of oil prices?  Is the world consuming too much, or is it that out-of-control speculators are responsible for today’s unsustainably high prices?  In truth nobody knows for sure, but it is probably a bit of both.
  • Given that we are an island destination, our visitors can only get here by air or by ferry so the future well being of tourism is very dependent on there being adequate oil supply at reasonable prices, for both producer and consumer.
  • Consider this.  The Chief Executive of Northwest Airlines, Doug Steenland, appeared before a Congress Committee in Washington D.C. last week, and among other things he pointed out that, “worldwide daily demand for oil had only increased by 2% in the past year although the oil price had risen by 100%”.
  • Doug is strongly of the view that speculation in the commodity markets is a major cause of the rise in the price of oil.  He says the volume of speculative activity is excessive and that additional regulation is necessary because it has placed upward pressure on oil prices irrespective of market fundamentals.
  • On the other had, Tony Hayward, the Chief Executive of BP, said yesterday that the argument that speculators are to blame is a myth, adding that supply was not responding adequately to rising demand.
  • So where is all this oil coming from and who is using it?  The following are the top 10 world producers according to the Financial Times, with the number of barrels per day shown:
Saudi Arabia 11 million
Russian Federation 9.8 million
USA 6.9 million
Iran 4.3 million
China 3.7 million
Mexico 3.7 million
Canada 3.1 million
UAE 2.9 million
Venezuela 2.8 million
Kuwait 2.7 million
  • But here’s the more interesting thing, who are the top consumers, again barrels per day:
USA 20 million
China 7.4 million
Japan 5.1 million
Russian Federation 2.7 million
Germany 2.6 million
India 2.6 million
South Korea 2.3 million
Canada 2.2 million
Saudi Arabia 2.0 million
France 1.9 million
  • High oil prices have widespread economic impact across all sectors, but perhaps none more so than in aviation.  In March of this year the International Air Transport Association (IATA – they represent over 90% of the world’s airlines) were predicting an industry profit of $4.5 billion for this year, based on an average oil price of $86 a barrel.  “For every $ that the price of fuel increases our costs go up by $1.6 billion”, says IATA.
  • Fast-forward to June and IATA believe that with an oil price of $135 per barrel for the rest of the year, the potential loss for 2008 could reach $6.1 billion.
  • Over the past 60 years the aviation industry generated $11.5 trillion in revenue and just $32 billion in profits.  Average margin has been just 0.3%, and the industry carries $190 billion in debt.  Since 2001, airlines have achieved massive change, fuel efficiency improved 19% and non-fuel costs dropped 18%.  But of course the skyrocketing price of oil has eaten up those gains, and then some.
  • So, challenging times ahead would appear at this juncture to qualify for the understatement of the year award.  Nevertheless, aviation has achieved remarkable things in the past and will again.  Science and technology will find ways to progress, just as the industry went from the Wright brothers to the jet age in 50 years.
  • The industry intends to improve fuel efficiency by a further 25% by 2020, and they have an even bigger plan, to build and operate a commercial airliner that produces no net carbon emissions, within the next 50 years.
  • In the much shorter term the world needs to establish what really is driving the price of oil and deal with that.  Otherwise the prediction by the President of OPEC last Thursday that prices could reach $170 a barrel in the coming months could come to pass.  He says the reasons are a weak US dollar and pressure on Iran, and he also says “there is more than enough oil in the market to meet international demand”.
  • But on the other hand a spokesman for Gazprom, the Russian energy giant, said last week too that OPEC had no real influence on the global oil market anymore.  His cheery view is that competition for energy resources was growing all the time, and he predicts $250 a barrel next year.
  • And just when you thought you had all the bad news, today ABC News, citing a Pentagon source, says Israel is likely to attack Iran’s nuclear facilities this year.  That’s not likely to do much for price moderation, were it to happen.  Indeed it could make the predications by the men from OPEC and Gazprom look modest, for a time at least.
  • “Take away the excess speculators who are in the market purely for the ride, and oil prices could drop by half”.  That’s the view of Michael W. Masters, a hedge fund manager who’s been advising Congress this year.  “There are no lines at the gas pumps and there is plenty of food on the shelves”, said Masters.  If only it were that simple, but the sad reality for now is that no one knows for sure what’s the cause of the high prices.  Let’s hope they find out soon.
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