FYI | Jun 23 2008
By Greg Peel
They came, they met, and the world was disappointed. Following a gathering of oil ministers from OPEC and of ministers from other countries in Jeddah yesterday Saudi Arabia announced that it would confirm its previously announced daily production increase of 200,000 barrels but would not, at this time, increase production any further.
The Saudis would be prepared increase production in the future, but only if there was actual demand for crude from world refineries. As there is little demand for crude at present beyond what normal production can satisfy, OPEC is standing fast. The high oil price, the ministers claim, is all about speculation, brought about by the credit crunched falling US dollar and geopolitical tension. There was also doubt expressed as to whether Saudi production increases, such as the earlier 200,000bpd offering, really make that much difference to the price.
It was the other members of OPEC who really put the kybosh on production increase calls from the developed world. There is still a risk that other OPEC producers such as Libya and Venezuela may actually reduce their own production to offset the increased Saudi production to date. And which ever way you look at it, Saudi Arabia’s heavy crude was never going to have a huge impact on gasoline refining, given gasoline needs the lighter crude that is presently being held up by rebel activity and strikes in Nigeria.
And Israel holds the oil price firmly in its hands at present, given its rising aggression towards Iran. The US also appears to have conceded defeat on increased OPEC production, and is now talking about opening up more offshore oil fields in its surrounding waters. There may be ten year’s worth of supply available, President Bush claims. However, it would take ten years of development and construction before the first drop was forthcoming.
With no exogenous negative influence on the oil price in sight, the Fed’s rate decision on Wednesday is made even more difficult. However, consensus expects that the Fed will remain on hold at 2%. There is a strong argument for raising and a strong argument for cutting – both cancel each other out. The problem for the Fed, and indeed for all developed world central banks, is that we haven’t really been here before. In the oil-shocked stagflationary recession of the 1970s, central bank policy was to save the economy as the primary action and in so doing let inflation run free. It was only after inflation reached double digits and the world was plunged into even deeper recession that the Fed realised it had made a policy mistake. Thereafter, central banks have always considered inflation as the greatest problem to be addressed. And thereafter we have not seen the likes of the current stagflationary climate again.
If it wasn’t for the credit crunch, the Fed may have been able to raise rates happily, but the credit crunch has brought about recession by itself. And the oil price is where it is by virtue of a weaker dollar and investment switching out of inflation-affected stocks and bonds and into inflation-hedged commodities. So the true cause of the high oil price is the credit crunch, and hence one can see why OPEC – particularly those members who are enemies of the US – have little desire to increase production for the sake of the US or its allies.
If the Fed doesn’t cut the cash rate it’s bad news for the US economy, as there is still no end in sight for the ramifications of credit crunch nor the housing slump. If the Fed doesn’t raise the cash rate there is no relief for rising inflation which in turn will put greater pressure on the economy. It is the rockiest rock and the hardest hard place a central bank could find itself between. The other problem is it appears the ECB will raise its cash rate, putting even more pressure on the US to do the same. If the ECB raises, and the Fed doesn’t, it means more downward pressure on the US dollar and thus more upward pressure on oil prices.
The economic data week kicks off in the US on Tuesday with the April house price index, the June consumer confidence measure, and the Richmond Fed’s economic index for June. On Wednesday it’s the rate decision, along with May durable goods orders and May new home sales.
Thursday sees May existing home sales, and yet another go at the first quarter GDP. It has already been stated twice at plus 0.6%. Friday brings May personal income and the personal consumer expenditure (PCE) deflator (an alternative inflation measurement), along with the Michigan Uni consumer confidence measure for June.
It is the quietest of economic weeks in Australia. Monday brings May vehicle sales and Thursday May job vacancies. That’s it.
