There
was a time when global oil prices reflected changes
in real demand and supply of crude petroleum. Of course,
as with many other primary commodities, the changes
in the market could be volatile, and so prices also
fluctuated, sometimes sharply. More than any other
commodity, the global oil market was seen to reflect
not only current economic conditions and perceptions
of future activity, but also geopolitical changes
and cross-currents.
Ever since the early 1970s, when group of some major
oil exporting countries OPEC, forced a three-fold
increase in global oil prices its shadow has loomed
large. There is still widespread perception that the
cartel of oil-exporting countries can manipulate and
influence the price by changing the level of their
own supplies. As a result, even oil-exporting countries
that are not members of the cartel have benefited
from OPEC's decisions about supply, since they have
also been beneficiaries of rising oil prices.
But in fact, OPEC is more like a club of a minority
of oil producers, rather than a cartel that is in
command of world oil supply. It controls less than
40 per cent of world oil production, compared to 70
per cent in the early 1970s. Non-OPEC countries account
for increasingly significant proportions of global
supply: Russia has overtaken Saudi Arabia as the largest
supplier of crude oil since 2009. Partly as a result
of this, OPEC has recently been quite inefficient
in imposing any kind of production quota on its members,
who have happily increased or decreased their production
as they wished. Most of its members are producing
exactly as they would if OPEC did not exist.
Indeed, for the past two decades, OPEC's role has
generally been more towards price stabilisation rather
than pushing for increases, and it may even have played
a moderating role in oil markets, including when particular
events such as political disruptions in major exporting
countries caused sudden supply shortfalls. OPEC formerly
abandoned its declared price band in 2005, and since
then has been largely powerless in determining prices.
The argument that rising demand from China and India
has determined the upward trend in global oil prices
is also unjustified. While these two countries (and
particularly China) do account for growing (but still
small) shares of global demand, these increases have
been counterbalanced from slower demand from other
regions of the world, including the US and Europe.
As a consequence, on average, global oil demand has
continued to grow at between 1 and 2 per cent per
annum over the past five years, usually at a rate
slightly below the annual rate of increase in global
oil production.
Recent price changes in global oil markets are increasingly
affected by other forces, which have more to do with
financial speculation and expectations than with current
movements in demand and supply. Chart 1 indicates
the extent of the recent rise, and shows how much
it mirrors the earlier rise in oil prices between
January 2007 and June 2008.
Chart
1 >> Click
to Enlarge
This confirms the points made earlier about the role
of other factors in global oil markets. Clearly, this
extent of price volatility – with dramatic rise, fall
and rise again within the space of three years - cannot
be the result of real demand and supply changes. Despite
this, most mainstream media persist in trying to isolate
some factors affecting production in particular locations,
to account for the price changes.
The ongoing crisis in the Middle East – and particularly
Libya – is generally believed to be the impetus behind
the latest spurt in prices. But Libya produces less
than 3 per cent of global petroleum output, and Saudi
Arabia (whose current excess stocks are already more
than annual production in Libya and Algeria) has already
made up current shortfalls and promised to compensate
for any future shortfall. Since the unrest in the
Arab region began, there has been no significant change
in global oil production, which continues to average
around 88 million barrels per day.
In any case, currently global spare oil capacity is
closer to historic highs than to historic lows. Proven
reserves of oil amount to more than 40 years worth
of global consumption at current levels – the highest
such ratio in the past thirty years.
The current price spike is therefore not the result
of demand and supply imbalances but is driven by uncertainty,
rumour and speculative financial activity in oil futures
markets. Even in terms of expectations, Libya is only
part of the problem (and in fact oil production still
continues in many Libyan facilities despite the civil
war). The concern in financial markets may be more
about the potential endgame if the unrest spreads
to Saudi Arabia. But the increase in oil prices is
happening well before such a drama actually plays
out, and before any serious disruption to global supply.
It is therefore likely that the rapid increases in
oil price and the associated price volatility over
the past year in particular, are largely driven by
purely financial activity. This is very similar to
the effects of financial speculation on other commodity
markets such as food items. The volume of trading
in crude oil futures contracts has expanded dramatically
over the past decade. As noted by Robert Pollin and
James Heintz (''How speculation is affecting gasoline
prices today'', Americans for Financial Reform mimeo,
July 2011), the overall level of futures market trading
of crude oil contracts on the New York Mercantile
Exchange is currently 400 percent greater than it
was in 2001, and 60 percent higher than it was two
years ago. Even relative to the increases in the physical
production of global oil supplies, trading is still
300 percent greater today than it was in 2001, and
33 percent greater than two years previously.
The ratio of ''open interest'' contracts of NYMEX
(New York Metals Exchange) crude oil futures to total
global oil production is one useful indicator of the
growing extent of speculative activity in this market.
This ratio was between 4-6 per cent in the first half
of the 2000s, increased to 12 per cent in late 2006
and then to as much as 18 per cent just before the
oil price peaked in June 2008. It then fell to 13
per cent in the middle of 2008, as oil prices fell.
It has been mostly rising since then, with average
levels of 16 per cent in the past few months. Large
traders in particular show growing volumes of ''long''
positions that anticipate future price increases.
(Data from Commodity Futures Trading Commission website
www.cftc.gov
accessed 6 July 2011).
While this explains some of the recent volatility
witnessed in oil prices, there are some other more
puzzling features of the recent price increases. Earlier,
the three major forms of crude petroleum in the global
market – Brent Crude, West Texas Intermediate and
Dubai crude – generally showed similar if not identical
prices. If anything, the price of West Texas Intermediate
oil used to be slightly higher because of perceived
better quality and lower sulphur content.
However, in the very recent past the prices have diverged,
and as Chart 2 shows, West Texas Intermediate is now
the lowest of the three prices. By the middle of June
the difference was more than $22 per barrel. It is
not fully clear what is causing this deviation, especially
the increasing extent of it. But it is also true that
futures market activity is greater
for both Brent and Dubai
crude oil.
Chart
2 >> Click
to Enlarge
We all know who loses from rising oil prices: most
of us. Oil prices directly and indirectly enter into
all other prices, through higher fuel costs of production
and transport. Agriculture is directly affected, so
food prices will definitely rise further with this
oil price increase, worsening the resurgent food crisis.
Such cost pressures have another consequence: they
push governments to inflation control measures, such
as higher interest rates. In many countries this worsens
the chances for the already fragile economic recovery
after the crisis. So people across the world face
lower real incomes and may face reduced employment
opportunities.
Oil-importing developing countries tend to get hit
much worse than other oil importers. First, the energy-intensity
of output is still much higher (twice on average)
than production in OECD countries. Second, developing
countries are often more foreign exchange-constrained
and so high oil import bills lead to balance of payments
difficulties. The poorest countries are usually the
worst affected, and within developing countries poorer
groups take the brunt of the impact in higher costs
of living and lower wage prospects.
So the doubling of the oil price that we have seen
in the past year has already destroyed any positive
effects of foreign aid that oil-importing developing
countries receive. Since it is also linked to global
food prices the negative effects are compounded for
food importing countries. During the last such price
peak in 2008, there were calls for compensatory financing
to be provided to oil and food importers by the IMF.
This never came about, but this time round we have
not even heard such noises, certainly not loudly enough.
Who gains from the rising oil prices? The conventional
approach is to look at the countries that are major
oil exporters, and somehow assume that they are the
beneficiaries of such price spikes, and that this
leads to a redistribution of global income away from
oil-importing to oil-exporting countries. This approach
is reinforced by the media, which keeps emphasising
the windfall gains of governments in oil exporting
countries.
But this misses the point. The really big gainers
– accounting for the largest portion of the gains
by far – are the big oil companies. In fact, big oil,
which suffered a setback during the Great Recession,
is back with a bang, riding on the back of the recovery
in petroleum prices in 2010. The major oil companies
that announced their results in January 2011 reported
a doubling of profits in 2010 compared to the previous
year. The three big US companies ExxonMobil, Chevron
and ConocoPhillips together had nearly $60 billion
profits after all costs and taxes. The profits of
the Anglo-Dutch company Royal Dutch Shell also doubled,
even though production was lower than expected.
Why do profits of big oil companies increase so much
during periods of high or rising oil prices? Basically,
the costs per barrel of the companies reflect their
historical costs of drilling, exploration and/or purchase
of crude oil, which often have little or nothing to
do with current crude prices. But they are quick to
pass on current crude oil prices to consumers in the
form of higher prices for their products. By contrast,
they tend to be much more lethargic about passing
on lower crude prices in the form of lower prices
of processed oil. So increases in crude oil prices
lead to enormous windfall gains for these companies.
In the current price surge, therefore, the real (and
maybe only) gainers are financial speculators in oil
futures markets and the big oil companies that can
pass on much more than their own costs in the form
of much higher prices due to the general sense of
frenzy in oil markets. So the case for immediate and
substantial taxes on the windfall oil profits of multinational
companies is very compelling. And so is the case for
much more far-reaching and effective regulation and
control of the speculative activity in oil futures
and other commodity markets that is currently causing
so much collateral damage.
*This article was originally
published in the Frontline, Vol.: 28, No. 15, July
16-29, 2011.
