Complex Made Simple

Is the price of oil too high or too low?

Commodity costs have sky rocketed and hit record levels in the past months, fuelled by rising oil and gas prices, which have been hovering near all time highs.

Last Friday the WTI-oil futures contract fetched its biggest-ever (in US dollar terms) daily increase over $139.

Saudi Arabia’s oil minister, Ali al-Naimi, recently pointed out that this strong move was ‘unjustified’.

The recent spike was incredible, and some analysts and traders said that this rally wasn’t supported by stockpiles or commercial demand.

The weaker dollar, thanks to dramatic unemployment figures –the US unemployment rate soared to a level of 5,5% in May – also contributed to the rise in oil prices, as have mounting tensions between Israel and Iran caused a rising oil price.

The Group of Eight (G8) industrial powers met at the weekend, along with India, China and South Korea in northern Japan amid deepening worries over record oil prices.

Energy ministers from the G8 opened talks after United States and Asia’s four largest powers expressed ‘serious concerns’ that the global economy was under threat.

The 11 nations involved in Sunday’s meeting, total nearly two-thirds of the world energy demand.

Of course the hands of the leaders are tied, since they cannot control oil prices.

International cooperation on energy saving

So, the only thing the 11 nations involved could do is to open discussions concerning initiatives for international cooperation on energy saving and developing clean energy, including plans by individual countries. Japan, Europe and the United States have been discussing creating a framework for exchanging information on energy-saving practices.

The driving factor behind the high oil price, which has soared five-fold since 2003, also is a shift in world demand. Rapidly developing countries like India and China have also increasingly stepped up as mass oil consumers.

Investment bank Morgan Stanley said on Friday that crude may reach $150 a barrel due falling inventories and tighter supplies, outweighing weakening global demand.

Goldman Sachs, the most active investment bank in energy markets, put out a bolder statement and was one of the first parties to point to a triple-digit oil price over two years ago.

Last month, the big energy player stated that oil could shoot up to $200 within the next two years as part of a ‘super spike’. ‘Demand for oil is weak (because of the downturn of the US economy) but supplies are even weaker’, according Jeffrey Currie of Goldman Sachs. The global head of commodities research cited supply disruptions in Nigeria and struggling output rise in Russia.

Oil price speculation

Some traders believe that there’s too much speculation in oil prices and that it has become a ‘classic speculative bandwagon’ with investors piling in with the hope of more gains ahead.

Even OPEC-president Chakib Khelil said that the dramatic price increase ‘is not justified in terms of market fundamentals, because supplies are sufficient.’

In the current mediocre stage of the US economy – and therefore the world economy- it will be interesting to observe how the oil price will develop in the future.

As long as the dollar remains weak and China and India’s demand remains strong, oil prices will keep rising. Of course, oil prices might correct, as has occurred in the last few days. But the previous couple of years, these retrenchments merely appeared as nice buying opportunities.

The question is; how high will oil prices rise? If we believe Goldman Sachs, current price is still far too cheap.

See also:
Oil prices propel GCC inflation surges
Oil producers resist production hike calls