The rise in the cost of a barrel of oil seems to never cease, with an average of 150 USD per barrel these days. Certainly this is causing much concern as oil price increases have ramifications across all market sectors. Most significantly for the average consumer, it is a major contributing factor in the increase of food costs worldwide. The worst sufferers are developing countries, with their limited financial resources and poor nutritional capacity. But even the wealthiest countries are suffering from the threat of recession due to global inflation and the direct correlation between the price of oil and food.
A few weeks ago, Saudi Arabia took the initiative and hosted a meeting in Jeddah to tackle the problem, bringing together all oil consuming and producing countries, as well as international institutions specializing in finance and energy. Their aim was to establish a common strategy to control the prices, some attended with the intention to decrease them.
Saudi Arabia kicked things off by demonstrating goodwill in its keenness in bringing down oil prices by stating that it would raise output by a further 200,000 barrels a day. Though a positive step, this move was more for show than effect. This is because the problem lies not in the levels of production, rather in the refineries which are not providing enough coverage for the market.
It is only natural to ask why the Kingdom decided to take such an initiative in holding this conference and what did they hope to achieve. To understand you must look back at history. You see, Saudi Arabia was one of the three founding states of OPEC in the early 1960s, and for years it has been at the helm of global oil production. It produces a whopping average of 10 million barrels daily. Moreover, it boasts the largest internationally known oil reserves estimated at about 25 per cent of total world reserves. Hence, it can be said that future politics of oil and energy depend on cooperation between the Kingdom and Russia, which houses 30 per cent of the global gas reserve and has the third largest oil reserves. Without such an agreement, prices and production can never be controlled.
After two significant oil crises: one in 1973, due to the Arab-Israeli conflict, and another in 1978/9, after the Iranian field workers’ strike, today’s price hikes seem to be the worst. The causes of which are as follows: firstly, the sudden collapse of the dollar, secondly the increase in the demand for oil and its derivatives and thirdly the issue of refineries.
The collapse of the dollar over the short duration of two years was a big blow. After all, the US Dollar is the official currency for oil pricing and the pillar of the international monetary system. The swift decrease was due to the desire of the US to lower pricing of local goods in order to limit importations and promote exportations. This desire was expressed through pumping huge amounts of money which raised liquidity in the American market as well as debts of consumers, especially holders of credit cards.
A crisis emerged in a later phase due to the financing of house purchases without sufficient securities. It seems this crisis that started in England more than a year ago will cause estimated losses of 1 trillion USD. Moreover, the crossing international bank interests and programs led by American banks to promote house loans in Europe are all issues that will smite the latter with losses exceeding 400 billions USD of which 120 and 50 billion USD will be incurred by England and Switzerland respectively. Hence, many have lost all trust in the US dollar and several have demanded an overhaul of the bases of the international monetary system, including President Medvedev of Russia at the recent conference of Saint Petersburg.
The significant increase in the demand for oil and its derivatives can be, to some extent, accredited to the annual growth rates in China at 10 per cent, India at 9 per cent, and Russia and Brazil at 8 per cent each, vastly outnumbering their peers in industrial countries. I personally believe Turkey should be added to the list too.
Nevertheless, the need for oil and its derivatives did not only soar because of economic growth in these countries, but also due to the fact that the aforementioned countries still lack the number of cars proportional to their agglomerations, surfaces and distances between their cities. These countries also aim at improving their standard of living which requires providing HVAC systems in addition to energy for industrialization and lighting.
Back to the Middle East. Ever since the 1970s oil production in the region has slipped from the grasps of international oil companies. The upside for these companies is that they are gaining more from the refining and distribution process.
It is known that that refining facilities require long-term planning. Modern refineries require a five-year period for design, location determination and implementation but major companies have maintained a policy of building refineries to suffice needs without ever going beyond it. But recently they faced sudden, mammoth and unexpected demands from India, China, Turkey and to a lesser extent Brazil. This lead to the increase of derivative prices which are a tool by which risk can be transferred by taking the opposite position in the underlying asset. The real risk being the threat to the worldwide economy given insufficient process of energy refining that can only be exacerbated further should any damage afflict one of the existing refineries.
So, what now? Industrial countries should adopt new fiscal policies inhibiting large companies from their current exactions which could lead to the financing of new refineries.
Furthermore, countries such as China, India and Turkey should do their bit in helping to impose reasonable prices for energy consumption by decreasing demand by 2 per cent. This would be more than sufficient in helping to stabilize and maybe even decrease prices.
Above all, American authorities must approve conservative monetary policies and refrain from setting the foundations for further crises. These crises will harm both investors and the dollar, and in turn oil prices. So the real burden of responsibility lies on American shoulders in this current predicament, and not on oil producing countries. Saudi Arabia for example, is dedicated to a policy that provides oil to different countries at reasonable conditions. In this regard the Kingdom is leading the way, for this should be a global paradigm.
