For the past couple of months, oil price had fallen from a high of US$78 to a low of US$57. Many reasons were given, ranging from rising US oil inventory to quieter than usual hurricane season in the Caribbean. Consequently, that gave the Dow Jones an excuse to rise on the back of an ?improved? consumer sentiment.
But what are our convictions for oil prices? We have no confidence in predicting the price of oil in the immediate short term. But we have an opinion on where oil prices are heading in the long term?we believe the direction is up. What is the basis of our conviction?
Firstly, we look at the fundamentals?the dynamics of supply and demand.
On the demand side, the rises of China and India in the 21st century, with their massive populations, will have an immense impact on the world?s total demand for oil. As the East (China and India) get wealthier by the day (see our article, Transference of wealth from West to East), you can expect the rise (in numbers and prosperity) of their middle-class to increase the strain on the earth?s resources. Today, the US, with a population of only a fraction of China and India, consumes far more than its proportionate share of the earth?s resources. Imagine how much China and India will consume as they attain towards the current living standards of the US! Next, we have to ask ourselves another question: will the increase in usage of alternate and renewable energies eventually supplant the usage of oil? While we do not know how the usage of such energies will turn out in the future, we can be sure that it will take quite a long time for the world economy to retool and wean itself from oil. This is because the world economy is running on the basis of cheap and abundant energy.
Now, let?s look at the supply side. According to a growing consensus in the scientific community, the world is approaching the stage of Peak Oil. Put it simply, the Peak Oil theory states that the world?s oil production has reached the peak and is entering the stage of terminal decline. One common misunderstanding of Peak Oil is that the world is running out of oil. No, the world is not running out of oil?the world is running out of easily accessible oil. This factor, along with the inadequacy of the world?s oil infrastructure led to dwindling of the global spare oil capacity to a 20-year low. With razor thin spare capacity, all the world needs is an unexpected supply disruption to cause oil prices to shoot up as it had happened recently. Thus, as the article in the Sydney Morning Herald said, there is an urgent need to increase global oil production capacity:
THE world’s top finance ministers and central bankers will meet in Melbourne next week to discuss attracting $US8 trillion ($10.4 trillion) in energy investments to avoid production shortfalls.
The startling forecast of the 30-year investment funding needed to bolster inadequate oil and gas capacity – which implies that the oil price could soar far above yesterday’s $US59 a barrel – is in an International Energy Agency report commissioned by the G20, which is to meet on November 18 and 19.
A third factor may lead to increase in oil prices?monetary inflation. Since oil is priced in US dollars, any deterioration in the quality of the US dollar will have an upward effect in the nominal price of commodities, oil included. We will discuss this issue in more detail in the future.
