Archive for the ‘Oil Price’ Category

What is Driving Oil Prices?

August 11, 2008

For years analysts have blamed rising crude prices on OPEC’s export levels while OPEC denied the charges, saying price increases have more to do with speculation and geopolitical jitters. Now, even skeptics are beginning to say rising oil prices may have more to do with non-OPEC factors.

The oil cartel, which produces about 40 percent of the world’s crude oil, says it is not responsible for the price of crude increasing to a record high of $100 dpb January 2. OPEC said the declining dollar—which has fallen nearly one-third in the past five years—speculating investors—who buy and sell commodities based on perceptions, which are often times inaccurate—and geopolitical jitters have led to inflated oil prices.

OPEC’s Secretary General Abdalla al-Badri told a press conference, “The market is very well supplied. The market is not controlled by supply and demand. It is totally controlled by speculators who consider oil as a financial asset.”

Ali al-Naimi, the Saudi oil minister, told a press conference, “Everyone knows that OPEC has renounced the principle of controlling oil prices since the 1980s. Since then, the price has been determined by the market. The fluctuations you are witnessing today have nothing to do with OPEC actions.”

For years skeptics have dismissed OPEC’s claims that price increases are based on exogenous factors, but recently many analysts are beginning to accept that many forces pushing prices upwards, are out of the control of the oil cartel.

Many forecasters now agree that oil is very easily manipulated by speculation and there are many reasons driving speculators: oil is prone to supply disruptions caused by factors including severe weather conditions and war; oil is a commodity with many components affecting prices, including producers, refiners, shippers and distributors. It is because of the obscure nature of the commodity that it is difficult to estimate exactly how much oil is in any given place at any particular time and because of this, estimates can quickly change. It is because of its volatile nature, that traders can profit from daily and even hourly price fluctuations. If enough traders speculate oil prices will rise in the immediate future, oil futures contracts will rise in accordance.
Other non-OPEC factors that have contributed to rising crude prices are increasing demands from countries like China and India, political instability and severe weather forecasts, which may impede production and export.

While many analysts agree that there are a wealth of non-OPEC factors causing the price hikes, they still point to OPEC, whom they say has not increased supply to counter and stabilize the prices. The Washington Times reported that OPEC curbed crude production for most of the year until last November, when it increased its output by 500,000 bpd. The cartel said it boosted its output to calm the market, but the increase did little to stabilize prices.
Last fall, with prices floating around $60 dpb, OPEC ministers agreed to cut output by 1.2 million barrels a day to try to drain off what they saw as overly large international oil inventories.

In December, after the initial cut, the cartel agreed to a second cut of 500,000 bpd. But oil prices responded by falling quickly in January to near $50 dpb, their lowest level since mid-2005. Joseph Stainslaw, an energy adviser at Deloitte & Touche USA LLP, said, “There is no current shortage, but no one deals on today’s market. They make deals based on tomorrow’s market. And that’s what they’re worried about.
“OPEC has become more a responder to events than a mover of events. OPEC can promise but it can’t always deliver.”

Shane Sweet, chief executive of the New England Fuel Institute, said, “Wall Street greed is pushing the American family and our small business to the breaking point.”

The International Energy Agency (IEA) says international political tensions, specifically between Iran and the United States, may decrease supplies in the face of increasing demands. The IEA estimated political tensions in Nigeria, another key supplier of crude to the U.S., has shut down upwards of 500,000 barrels of production a day since 2006. In Venezuela, crude production has declined since 2002 and is predicted to decline further as a result of the country’s recent nationalization policies. Instability in war-torn Iraq has also added to rising prices.

While Russia and members of the former Soviet block have increased production in attempt to counter this decline, the decrease in production by non-OPEC nations like the U.S., Britain, Norway and Mexico have offset any increased output.

Fereidun Fesharaki, the chairman and CEO of the Facts Global Energy company and former president of the International Association for Energy Economics, told the Iran Times, “The reason for higher prices is a fundamental understanding that we are running out of oil—not just because resources are getting exhausted—but because many of the sovereign governments who own the oil want to produce in a way to ensure long term supply availability for future generations in their own country. Key OPEC countries, Saudi Arabia, Iran, Kuwait and Venezuela, do not allow foreign ownership of their oil resources. Key Non-OPEC countries, like Russia and Mexico, also have restrictions on production and foreign control in their country for similar reasons.”

Fesharaki said investment speculation does play some role in increased prices, but not a major one. “Hedge funds and financial institutions have been blamed for the higher price of oil. We believe only $5 to $8 of the price may be due to this and another $10 due to geopolitics, but fundamentally it is the supply constraint in the long term, which raises the prices. We expect the price of oil to reach $105 by 2010 and can go as high as $150 by 2015.”

The IEA agrees, placing the blame not on speculators but on increasing global demands and sluggish supply increases. The agency says that an even bigger worldwide energy crisis is possible within a few years as a result of rapid economic growth in China, India and other emerging countries combined with slow production increases by major oil exporters, which could lead to oil shortages by 2015. “A supply-side crunch in the period to 2015, involving an abrupt escalation in oil price, cannot be ruled out,” the IEA reported.

Daniel Yurgin, chairman of Cambridge Energy Research Associates (CERA), attributed the price hikes to a “demand shock, not a supply shock,” and said, “The oil market is demonstrating both ‘fright and flight.’ Instead of the proverbial ‘flight to the dollar’ in times of economic uncertainty, we’re now seeing a ‘flight to oil.’ The strengthening of oil since August is responding, in part, to the weakening of the dollar. For the last few years, the force behind rising oil prices has been strong global economic growth. Over the last several weeks, the market focus has shifted to economic weakness in the United States.

“Right now, as dollar pain persists, every country holding large reserves of dollars, including petrodollars, is rethinking its allocation among currencies and considering how much to diversify away from the dollar,” Yurgin said.

James Burkhard, Managing Director of Oil and Gas Group, Cambridge Energy Research Associates, and director of CERA’s Dawn of a New Age: Energy Scenarios to 2003 study, said, “Prices in the high $90s and $100s can over push both the economy and geopolitics into unchartered waters. The unprecedented $30 surge in oil prices since August, from $70 to $100, reflects a sharpening mix of concerns about the value of the dollar, the adequacy of oil supplies and economic weakness combined with an Iran premium. A potential pressure valve, a reduction or even softening in demand, has not yet become apparent. But in the $90 to $110 range, it becomes likely.”

Last month, CERA put the record at $99.04 dpb, a level it said was reached in inflation-adjusted terms in April 1980. The IEA agreed that April 1980 was the peak month, but it translated the price to $101.70 a barrel in today’s dollar.

The Energy Department’s Information Administration has a completely different view. It said the previous inflation-adjusted record, $93.48 dpb, was set in January 1981. That would make the price reached last November, $96.70 a barrel on the New York Mercantile Exchange after a $2.72 increase, a new record closing price. The price reached $97.10 during trading.
Two key factors account for the difference: which price is used as a benchmark and which inflation rate is used to translate into today’s dollar.

The New York Mercantile Exchange did not establish crude oil trading until March 1983. So Cambridge Energy used what was known as the average “posted price” that U.S. producers said they would charge for crude oil. It varied every month. In April 1980, it was set at $39.50 dpb in 1980 dollars.But Energy Information Administration (EIA) analysts said that the price U.S. refiners paid for imported oil is a better indicator. It said the posted price did not change from April to July 1980, suggesting that it wasn’t responding to events or market forces. The price of imported oil, by contrast, is “a fairly representative measure of world crude oil prices based on actual transactions,” the EIA said in a recently published report.

Some argue that is not an accurate measure either though. Today, improved refineries can use cheaper, lower quality oil than they could in 1980. This makes it difficult to compare today’s prices to those decades ago. Jonathan Cogan, a spokesman for the EIA, said imported oil today costs on average $2 to $3 dpb less than West Texas Intermediate, a type of crude oil used as a benchmark in oil pricing and the underlying commodity of New York Mercantile Exchange’s oil futures contracts.James Burkhard, who did the calculation of peak prices for Cambridge Energy, said, “The way we determine [oil] prices has fundamentally changed from early 1980s until today. It’s not a perfect apples-to-apples comparison.”

In addition to using different benchmarks, price levels differ based on what source the inflation rate is based on. While CERA and the EIA used an annual average inflation rate based on the consumer price index, the IEA used monthly figures and said the GDP deflator would produce a more precise figure. The Independent Connecticut Petroleum Association (ICPA) is taking a more political approach to solving the problem of increasing prices. For the past two years the ICPA and 79 other similar groups, have been lobbying to close what they term the “Enron loophole,” which they blame in part for increasing prices. ICPA says the loophole was created in 2000 when Congress absolved the U.S. Commodities Futures Trading Commission’s (CFTC) ability to track electronic trading outside the two major U.S. exchanges.The ICPA fears that some companies that have been investing billions of dollars into these electronic markets might actually be buying oil from themselves to inflate prices in a cycle of buying and selling that harms the consumer.

Last November, U.S. representative Peter Welch of Vermont introduced a bill to restore the CFTC’s power to monitor electronic trades of oil, natural gas, electricity and other similar commodities. The law aims to require hedge funds and other investment companies to report their trading activities on other exchanges in addition to the two major U.S. exchanges.
Eugene Guilford Jr., executive director of the ICPA, said giving CFTC its powers back won’t necessarily drop the price of oil, but it will remove doubts about whether the market is being manipulated.“The growing suspicion is the markets are not operating on the fundamentals,” Guilford said.

Guilford said one of the most common reasons given for the increase in oil prices is the weakening of the U.S. dollar, but he pointed out that the dollar was trading at $1.17 per euro in 2003 while a barrel of oil traded at $32 dpb. Today, a euro is worth about $1.48, which means the dollar has lost almost 30 percent in three years, while oil, at $96 dbp has risen almost 200 percent.

Bijan Mossavar-Rahmani, chairman of Mondoil Enterprises, an international oil and gas company, told the Iran Times there are several factors behind increasing oil prices, from speculation and geopolitical jitters in the Middle East to higher demand in places like China at a time of very little spare global production capacity.

“Another reason for increasing prices is that we haven’t invested more quickly to increase exploration and production because of lack of standby equipment, services and personnel. Even if we had the wherewithal, the growing resource populism or oil nationalism which came with higher prices and revenues has chased out the international companies from places like Venezuela and Bolivia, in turn reducing opportunities for adding to production longer term.

“Higher prices have yet to choke off demand because the drop in the dollar means that oil prices have not risen as much in terms of the euro or some other currencies,” Mossavar-Rahmani said.A spot crude trader active in 1980, who still trades with a U.S. producer and refiner, said, “You look at the fundamentals to determine why the markets goes up and down, and that just doesn’t work anymore.”Last November, Egyptian Energy Minister Chakib Kheili claimed an increase in production would have no influence on prices and OPEC’s Secretary-General voiced his opposition to increasing supplies. Saudi Arabia, OPEC’s biggest and most influential member, said rumors of supply shortages were “groundless.” “There is enough oil in the market. It’s the problems in Nigeria, in Pakistan and the credit crisis cause by the U.S. subprime-mortage-market collapse that caused prices to increase,” Khelil said.

U.S. Energy Secretary Samuel Bodman, however, said he wanted the organization to increase output and “a lack of willingness to supply the market” was one of the factors pushing prices to their record levels.

Falah Al-Amery, head of Iraq’s 13-nation State Oil Marketing Organization (SOMO), told the Dow Jones Newswires in a phone interview, “The market is very sensitive right now, and OPEC will be monitoring the situation very closely in the coming weeks ahead of its February 1 meeting. But the bottom line remains that if we find that the reason behind high oil prices is speculation and not demand and supply levels, then there will not be an [output] increase.”

Al-Amery said there are two groups in OPEC with different outlooks about price levels. “You have the hard-liners who are happy with a $100 per barrel price level, and you have the moderate member countries who understand it is bad for the world economy and would like to see prices fall back to the range of $70 to $80 a barrel.”

Iran, OPEC’s number-two exporter, spoke out against any hike in the cartel’s output. The IRNA quoted Iranian Oil Minister Gholham-Hossein Nozari as saying, “All the evidence shows there is enough oil in the world’s oil market and increasing OPEC’s quota will not have an impact on the global oil price.”Nozari said, “Iran’s average crude production capacity stood at 4.11 million bpd and 4.135 million bpd in Shahrivar [August 23 to September 22] and Mehr [September 23 to October 22] respectively.”Nozari said the 100,000 bpd production target would be possible through production of 25,000 bpd of crude from Azadegan field between November 22 and January 20 and of 50,000 barrels from the second phase of Darkhoein field ahead of the schedule, as well as an addition of 20,000 to 25,000 bpd to Behregansar field’s production capacity.

Javad Yarjani, the head of the Iranian Oil Ministry’s OPEC Affairs Department, told the Islamic Republic of Iran Broadcasting (IRIB), “The discrepancies that exist between statistics released on Iran’s oil production rate are due to incorrect reports by the EIA. Secondary sources claim that we are producing 3.7 million barrels of crude per day, but we reject these statistics as definitely inaccurate.”

Yarjani said Iran produces around 4.05 million barrels of crude per day, adding that distributing wrong data about a country’s crude production makes it prone to accusations of failing to carry out its OPEC commitments. “Most of these sources have ties to world powers, the US in particular, and are trying to sow discord among OPEC states by all possible means, including releasing distorted data,” he said.