Speculation driving crude prices up

Ever since multiplying escalations in oil prices in the 1970s wrought havoc in the West, then dominating the global economy, it has been axiomatic that they pose an uncommon threat, whether used deliberately or not. It was in that era that the term ‘stagflation' entered the fray, with the realisation that a higher import bill for a given volume of energy input suddenly imposed a drop in living standards both in terms of higher prices and lower growth. Governments that had complacently become used to the notion of managing demand as if fine-tuning the economy as a well-controlled — not to say well-oiled — machine suddenly became all too aware that sand had been kicked not only in their faces but in that machine as well. Attempts to offset that impact ran ruinously into the reality that this substantial supply shock could not just be finessed away by supposed technocratic sophistication. Indeed they exposed the underlying Keynesian mindset to a severe stress test, by which it was found wanting. The fact that certain governments today, confronted by a real bust after a financial boom, seem conveniently to have ‘unlearned' that lesson doesn't alter the fact. There's still no free lunch; in fact it just got more expensive. High oil prices are with us again now, though by stealth rather than design, steady accretion not rocket propulsion. And without reaching the same disorienting heights when measured in inflation-adjusted terms. Fear factor Yet, given the fragility of the economic times, a fear factor stalks again. Only this time it's different, worryingly so, insofar as the global locomotives now reside in the East. That story is so well documented as not to bear repetition, but it does mean that the West's vulnerability is heightened too. In that case, high oil prices might be the symptom of incipient resumption in world growth, but located mainly elsewhere, as much as the source of renewed downturn. As if the delicate state of US economic recovery and Eurozone monetary machinations weren't enough of a concern. The Gulf's own relationships with the West render it concerned too, notwithstanding the welcome windfall in its own receipts. Besides the geopolitics, high prices are known historically to sow the seeds of lower prices to come. Thus, Saudi Arabia's ability and willingness to meet customer demand is just as famed. The kingdom is recorded as currently raising production, to cope with the interruption associated with sanctions on Iran, besides recent declines in non-Opec sources such as Sudan, Yemen and Syria. Cyprus-based energy think-tank MEES says it's "noteworthy" that output remains well below capacity, which it puts at 12.5 million barrels per day (bpd). Still, longstanding MEES consultant Dr Walid Khadduri contends that there can be confidence in Saudi responsiveness, first because of the precedent in crisis conditions, namely of how it prevented serious shortages when Iraq invaded Kuwait (five mbpd "were wiped out overnight and … for approximately eight months"); second because "we haven't heard so far of any country or IOC visiting Riyadh and complaining afterwards that they won't receive supplies to substitute for the Iranian shortfall". Even so, he concedes, that's not to say that there aren't risk factors present relating to potential disruption and confrontation in the Gulf. Assymetric risk Moreover, Opec is "walking a tightrope" to keep prices restrained, says Daniel Kaye, analyst at National Bank of Kuwait, balancing supply flexibility with the attendant impact on spare capacity. That does sound quite like an asymmetric risk just now, one that puts global recovery in genuine danger. Conjecture on the level of spare capacity, whereby supply may meet demand, appears the key element driving prices at the margin in a speculative market. That leeway is essentially Saudi Arabia's — though Kuwait and the UAE have some modest scope to lift output as well. During 2011 Saudi boosted output "considerably" reacting to lost Libyan production, says Daniel Kaye of NBK, and did so fairly easily owing to a cushion in the order of four million barrels per day. As a result, however, spare capacity "may have fallen close to the two million bpd that the kingdom likes to maintain as a contingency". Dr Walid Khadduri, MEES consultant, notes that Saudi oil minister Ali Al Nuaimi says confidently that they do possess sufficient capacity, and repeats "around 12.5 million bpd" as the acknowledged limit. Francis Osborne of KBC Energy Economics suggests a general view of there being 11.5 million bpd at Saudi Arabia's disposal, as discerned "by filtering various sources". Fruitless discussion In extremis there could probably be another two million bpd beyond the current "high nines", though that's "a totally fruitless discussion, because nobody knows," he says. "It is an uncharitable supposition that those who say the slack is tighter are talking their own book," Osborne continues. Ultimately, since the market reacts as if it's so, "it doesn't matter whether there's [actually] a material constraint, it's almost irrelevant".