Sunday, March 6, 2011

Oil Markets and the Arab Unrest

With the price of a barrel of Brent crude around $115 (and peaking at $120) and West Texas Intermediate crossing $100, I thought this article from the Economist ("The Price of Fear") provides an excellent overview of what is going on in the oil markets.

Clearly, pricing is going up because of an increase in demand, particularly in the emerging world:

“World demand grew by an extraordinary 2.7m b/d in 2010, according to the International Energy Agency. It will probably keep growing by another 1.5m b/d this year and the same again next, as the rich world recovers and demand surges in China and the rest of Asia.”

However, it’s also worth noting how seamlessly the developed world has been able to cope with higher oil prices over the last thirty years and how out of whack energy intensity remains between the developed and emerging world.

“America’s economy in 2009 was more than twice as large in real terms as in 1980. Yet over that period America’s oil consumption rose only slightly, from 17.4m b/d to 17.8m. Europe actually used less oil in 2009 than in 1980, even though its economy had grown... America’s economy, though about three times the size of China’s, uses just over twice the amount of oil that China’s does. But oil intensity in emerging countries has also been falling in recent years, as manufacturing has become more efficient and less energy-intensive service industries have increased their share of the economy.”

In the short-term, there is no reason to believe that oil can’t take out its 2008 peak, particularly if social unrest begins to spread to the major oil exporters (Saudia Arabia, Iran, etc.). However, a sustained period of high oil prices remains unlikely in my opinion given the likelihood that elevated prices will throw the global economy back into recession (as we saw in the summer of 2008). Further, high oil prices will undoubtedly spark a new innovation wave that further reduces oil intensity throughout the world (not just in developed countries). The latter could take some time to play out, but human ingenuity should disprove those market commentators who confidently predict $200-$250 oil over the coming year.

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