The price of oil just keeps going up. It reached nearly US$123 in New York trading over night. The Masters of the World at Goldman Sachs repeated their claim that a ‘super spike’ in the oil price could drive it to US$200, on the back of red-hot demand in the developing world and the “non-recession” in the U.S. Supply bottlenecks won’t help.
Take a look at the oil price chart below from Gabriel Andre.
What does it mean? Reading an oil price chart is not like reading a star chart. But it does require a little interpretation. Here’s ours: the increase in the oil price between 2001 and 2006 was a structural revaluation of oil’s value to the global economy. You had the Iraq war driving the geopolitical premium.
Since 2003, you’ve had production peaks/declines in large fields in Mexico and Russia, persistent disruptions to Nigerian production (Nigeria is the world’s eighth largest oil exporter at just over 2 million barrels per day, nearly half of which goes to the U.S.), and gradually increasing demand from emerging markets.
But what happened in 2006? The oil price chart shows that prior to 2006, the world had come to grips with the idea that the era of cheap oil was over. In May of 2006, commodities as an asset class suffered a large correction and investors worldwide reconsidered how long the resource boom would last.
It’s possible-although it would just be a guess-to attribute oil’s meteoric rise since early 2007 to rampant financial speculation. In a recent article, William Engdahl suggests that as much as 60% of the current oil price is speculation. On the other hand, a research note from Citigroup predicts oil prices of US$40/barrel within two years? Who’s right?
Frankly, the oil price is hostage to a number of variables, many of which are not quantifiable. A fear premium definitely exists. Then there is the declining U.S. dollar. And there is the matter of investors treating oil as an asset class and as a “safe-haven” from inflation. The creation of sector funds and ETFs correlated to the oil price has made this possible.
And now? Well, like iron ore and coal, the oil price indicates that the emergence of China and India as productive industrial economies with an emerging consumer class is a lot more resource intensive than any of us imagined.
The oil price chart above suggests there’s a bubble and that it has to correct soon. But by “correct” we mean oil between $95 and $105. In 2003, $40 became the new $20. In 2005, $60 became the new $40. And in 2008… $100 becomes the new $60.
Markets and Money