Oil at $60 today; $100 tomorrow!

Reading commodity markets is about as difficult as predicting which way stock market prices will go. Even if you get the long term trend right, the market can go astray for long periods of time and catch out short-term punters.

However, oil market bulls currently appear to have the long and short-term market pulling in their favor. Commodity markets are like any other with supply and demand determining price, and the factors are often more transparent than in other financial markets.

It is hard to hide a tanker of oil heading towards a terminal, for example. And hard for oil speculators to pretend that something is wrong when it is not.

Thus in the summer of 2005 the oil market has the following characteristics: demand for oil is still rising strongly around the world on the back of a worldwide economic recovery, which while slowing down is clearly on an upward track.

At the same time, supply questions abound. We constantly have the threat of short-term supply interruptions all over the world, partly because oilmen now realize the power in their hands to upset markets. Then there is the continued insurgency in Iraq which is stopping oil output from rising or new capacity being installed.

Meantime, the long-term supply position is deteriorating. Russia is the world's second largest exporter of oil, and for the first time since President Putin took over output growth is slowing this year. Saudi Arabia is pumping more oil but even the sustainability of supplies from this source is being called into question by certain experts who do not appear to be cranks.

On thing that is sure is that refinery capacity around the world is insufficient, and that it would take five to 10 years of refinery construction to keep pace with expected growth in demand for oil products.

This does sound like a recipe for higher oil prices in the short-term, and probably into 2006. But at some point oil prices will go beyond what the world's economy can cope with.

Every major oil price spike in the past has resulted in a recession, so this present oil price boom is unlikely to be an exception. But thus far the world economy does seem to have absorbed $50-60 oil without collateral damage.

However, $100 per barrel oil will probably be another matter altogether. Inflation would begin to rise due to higher energy and raw material costs, central banks would have to respond with higher interest rates; and the combination of the two would inevitably undermine global economic growth.

Is the world economy therefore sailing into an old fashioned 1970's style energy crisis? On the face of evidence to date that would appear a fair conclusion.