Commodities | Jul 19 2006
By Greg Peel
The current oil futures curve rises from around the US$74/bbl mark to peak around the US$80/bbl mark in the first quarter of next year. Thereafter it tapers off.
The implication from this curve is firstly that there is sufficient oil around at the moment. The demand/supply equation is tight, but the only reason we’re testing highs again is due to Middle East conflict implications. This is shown in the "anything might happen" premium built into subsequent months. The longer term view is, however, that oil prices will recede (later in 2007).
The key to the short term oil price lies in this out-of-the-blue kidnapping of two Israeli soldiers by Hezbollah and the swift and surprisingly rigorous reaction from Israel. Israel’s determination is probably explained by Prime Minister Olmert’s claim that the kidnapping deal was all an Iranian ruse (Iran supports Hezbollah) to deflect attention away from its nuclear ambitions at the current G8 summit in Russia.
If this is true, it seems to have worked.
Any internecine missile lobbing between Israel and Lebanon has no direct effect on the oil price – neither country boasts any reserves. However, Middle Eastern conflict in general simply raises the possibility of more widespread conflict. If Syria (also a supporter of Hezbollah) were to reinvade Lebanon, having been kicked out only recently, then the fear is the whole region might erupt. Israel would be feeling more or less surrounded and would not likely take things sitting down.
The US is a strong supporter of Israel, as is the rest of the Western world in more general terms. This may well give Iran the excuse it might be looking for to cease its oil exports. (This is not a decision Iran would take lightly as it actually has no refineries of its own. Any cut in exports means no petrol coming back).
To date the pervading problems of a recalcitrant Iran, a recalcitrant North Korea, Nigerian insurgent disruptions, and not forgetting the war in Iraq, have kept the oil price up along with more specific tightness of supply. Now the market is building in a premium in the medium term for any escalation.
No one is tipping an all out Middle Eastern war, nor indeed expecting Iran to cease oil exports. But they are not discounting the possibility. In the meantime, George Bush has eloquently informed Tony Blair of his own solution: "See, the irony is that what they [Israel] need to do is get Syria to get Hezbollah to stop doing this shit, and it’s over".
Whether or not George’s master plan plays out, the world is facing a total insufficiency of spare capacity. Barclays Capital calculates spare capacity to be only 1.5 billion barrels per day, and all of it in Saudi Arabia. Now the Saudis might be US allies, and critical of Hezbollah, but they’re still in the Middle East.
Were there to be a crisis the US, and other nations, would be forced to call upon strategic reserves. In the case of the US there is enough to last a couple of years, but it’s there to avert other crisis possibilities, such as another bout of Katrinas.
All in all, it is the spare capacity problem weighing on the equation. Even if the Saudis fire up, they would still only be providing heavy crude which most refineries can’t handle. Look out for any escalation, or any new problems, shooting the price to US$100/bbl.
In the longer term, the pervading belief is that an oil price in the seventies will finally lead to some demand destruction. That’s taking a while, just as much as capacity increases are taking a while, but the fact that General Motors is unlikely to sell more than about two or three of its brand new, powerful V6 and V8 Commodores (or whatever name they go by elsewhere in the world) supports the longer view that the oil price will drift back to the US$50/bbl level eventually. Brilliant bit of foresight from GM – way to go guys.
Mind you, last year’s long term average price was more like US$40/bbl. Will it be US$60/bbl next year?