Why Oil Has Become So Expensive

By Siddiqi, Moin | African Business, November 2000 | Go to article overview
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Why Oil Has Become So Expensive

Siddiqi, Moin, African Business

Soaring oil prices are affecting consumers from the Americas to Europe, Africa and Asia. The world's politico-economic stability could be undermined by overheated energy prices during the northern hemisphere winter.

Crude oil hit a 10-year high at $37.8 a barrel in September, though prices fell in October when the US administration released 30m barrels from the nation's strategic petroleum reserves.

A combinations of factors are behind the inexorable rise in prices over the past year. There is no global physical shortage of crude oil. But there is an acute shortage of refined products, such as gasoline or middle distillates (diesel and heating oil). Petroleum stocks in the industrialised (OECD) countries are reported at their lowest level since the mid-1980s. The Paris-based International Energy Agency says that the refined products deficit is mainly concentrated in USA, which accounts for over 25% of global oil consumption.

The Organisation of Petroleum Exporting Countries (OPEC) is not responsible for the oil market's tightness, despite increasing accusations by western governments. The cartel is not the villain because its collective output has risen by 3.2m barrels a day (mbd) since last April and is supported by an 800,000 b/d increase in non-OPEC supply. But now OPEC is pumping at 95% full capacity, with only Saudi Arabia able to raise output within a month or two. Ali Rodriguez, OPEC president warns: "We are approaching a crisis of great proportions because oil production capacity is reaching its limit."

It is the oil majors who are responsible for the market's volatility. They have maintained relatively low stocks, reflecting increasing employment of 'just-in-time' inventory management. The West's oil sector has experienced consolidation, large cost cutting and declining investment in refinery capacity, (although their fortunate shareholders are receiving hefty dividends).

This year, the top four oil majors: Exxon Mobil, TotalFinaElf, Royal Dutch/Shell and BP Amoco are projected to earn record combined profits of $50bn, according to Lehman Brothers, the US investment bank. OPEC blames runaway prices largely on refinery bottle-necks in North America and Europe, speculative premium, and excessively high fuel taxes in European Union (EU) countries.

Global impact

Rocketing oil prices pose a risk of 'stagflation' (rising inflation amid negative economic growth), as during the 1973-74 and 1979-80 global recessions. Importing countries are facing a steep 40% increase in wholesale energy bills in 2000. A strong US dollar - the currency in which oil is priced - is worsening the impact especially across the African continent. As in the Euro zone, the rise has been much steeper in local-currency terms because of currencies depreciating against the dollar. Most sub-Saharan countries spend over a third of their foreign exchange earnings on fuel imports. South Africa's import bill is estimated to rise by Rl0bn. On the other hand, high prices will help non-OPEC countries like Angola, Gabon and Egypt.

Major equity markets are nervous about profit downgrades, especially in chemicals, consumer products and transport sectors, as well as surging inflation and interest rates. Share prices of industrial chemical groups, notably ICI (UK) and BASF (Germany) have dropped because of depressed profit expectations and higher costs.

Fuel crisis protests have undermined the credibility of EU governments, especially France and Britain. Some analysts warn of imminent l970s-style oil shocks. But such a scenario is remote because oil prices, in real terms, are still lower compared to 1974 and 1980. To trigger a prolonged recession in the OECD economies, prices would have to sky-rocket to $70 a barrel - an extremely unlikely event.

Since the early 1970s, the West has reduced its oil consumption thanks to greater energy conservation and investment in alternative fuels like natural gas.

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