Opec looks East
IF $80/b oil is a threat to the US economy, as some analysts claim, then prepare for a rocky few months. The world's dominant producers are in no mood to soften the market, even as it threatens to breach $85/b
Opec's decision to roll over existing oil-output quotas was no surprise, but it still reinforced the prevailing sentiment. Ali al-Naimi, Saudi Arabia's oil minister, said the group was "comfortable" with prices, despite their heady level at almost $10/b more than Opec's price target.
Other Opec ministers were just as content and argued – plausibly – that the group had brought stability to global oil markets following the collapse in prices of 2008 (PE 10/10 p24). Later that year, Opec slashed its quotas by 4.2m b/d and declared it would seek a "fair price" of around $75/b. The group's basket of crudes has averaged around that price in the past year (see Figure 1).
Now, however, some of Opec's price hawks are calling for higher prices. Crude at $90-100/b wouldn't harm economic growth, says Venezuela's oil minister, Rafael Ramirez. The fall of the dollar, now at a 10-month low to the euro, would justify much stronger prices, says Shokri Ghanem, chairman of Libya's National Oil Corporation. "No-one will hate oil at $100/b," he claims.
That's not true. Many in the West would object if oil prices rose by more than 33% above what Opec considers a "fair" price of $75/b. Anything above $80/b will hamper the economic recovery and employment prospects in the US, argues Stephen Schork, editor of market newsletter The Schork Report (see p13). The recovery is too fragile and the stimulus hasn't worked as its proponents hope, say some. The US economy needs another bout of energy inflation like it needs a shot in the head.
Stronger oil prices could also kill off the small shoots of demand growth in rich Western countries, believe some analysts. The International Energy Agency said in mid-October that OECD demand this year may turn out to have been "more resilient" than expected, although it will resume its "gentle structural decline" next year. In its most recent assessment of the market, Opec says almost all of the demand growth in 2010 is likely to come from non-OECD countries.
In that context, it makes sense for Opec to focus its pricing strategy on the markets of the East, where demand is still strong. On its own, China will account for half of the world's oil-demand growth this year, believes Opec. Its "overheating economy" has pushed demand up by 5.6%, the group says. In September, Chinese oil imports rose by 35% compared with the same month 2009, to a record 5.67m b/d. Oil demand in the month rose by another 5% compared with a year earlier.
For now, there is little evidence that another bout of rising prices will hit consumption in the key Asian markets. On a purchasing-power parity basis, consumers in China are already paying prices comparable with those in the US for their fuel, points out Peter Tertzakian, chief economist at Arc Financial, an investment bank (see p48). So the frequent claim heard in the West, that Chinese fuel subsidies distort the international oil market, lacks foundation.
In any case, "Opec doesn't think that $85/b is a demand killer," says Bill Farren-Price, head of Petroleum Policy Intelligence, a consultancy. "Flatlining OECD demand is neither here nor there. The East is where the growth is." Moreover, despite the continuing build of crude stocks in the West, new support for prices could come from monetary policies put in place in exactly those countries where economic growth is at threat from further oil-price inflation.
Another round of quantitative easing in the US, renewed fiscal stimulus and persistently low interest rates on both sides of the Atlantic could send another "wall of cash" into the financial sector, says Farren-Price. As long as the real economy struggles to find a place for this stimulus, much of it will end up in commodity markets. "If all this money can't find a yield, it will end up in oil," he says.
Indeed, the prospect of a second round of quantitative easing – QE2 – looks more likely by the day. US Federal Reserve chairman Ben Bernanke has already broached the topic and another dollop of worrying economic news in the country, in the form of poor job-roll and housing-market data, could push the bank back into the bond market. Another $0.5 trillion worth of QE2 could be announced early this month.
Whether it will work is debatable. By its very nature, printing money shows the Fed's lack of faith in the real economy. One thing it could do is exacerbate rising tensions between China and the US over their currencies, as the dollar plunges again. An out-and-out currency scrap between them looks to be the kind of battle the US economy could only lose.
Cheaper dollars send bulls into the crude market, because as the dollar weakens, traders compensate by inflating oil prices. Chakib Khelil, a former Algerian oil minister and one-time president of Opec, says a $0.01 movement in the value of the dollar against the euro is worth $5 on or off the oil price.
Inflation on the back of a weaker dollar now may be nominal in purchasing-power parity terms, but it has a psychological effect on consumers. The inevitable outcome of rising oil prices, while Western economies perch on the edge of another downturn, is further demand destruction. Look at the spike in prices of 2008, they argue, for a precedent.
Should producers care? That depends on where their customers are. The global oil market is going bipolar. The slow-growth developed world, led by North America and Europe, now offers little comfort for oil producers. Saudi Arabia now exports more oil to China than to the US, its strategic ally for most of the 20th century. Rising oil prices will exacerbate the West's decline as a market for Middle East crude.
But until the fundamentals pushing up oil demand in China begin to weaken, Asia's ascendency in global oil markets will continue, supporting oil prices along the way. Western economies will have to live with this, learn to deal with it and plot the kind of "oil-less recovery" their countries need. As economic power drifts to the East, the end of Western domination in the oil markets is nigh.