Whither oil prices?

OPEC Bulletin Commentary July-August 2006

The outbreak of hostilities in the Middle East in mid-July had an immediate impact on oil prices, taking them to record highs, in nominal terms.

This was in spite of the fact that there was plenty of crude on world markets, as, indeed, has been the case throughout the present period of volatility, which began in spring 2004 and has been characterised by continued upward pressure on prices.

The reasons for this protracted volatility are, by now, familiar to OPEC Bulletin readers and relate to an unusual convergence of factors: the exceptionally strong world economic growth and, in turn, oil demand growth, especially in developing countries; the slow-down in non-OPEC supply growth, although this is picking-up again; tightness in the downstream sectors of major consumer countries; geopolitical concerns; major natural disasters; and heightened levels of speculative behaviour.

Understandably, people often approach the OPEC Secretariat to ask how long this volatility will last and how far prices will rise.

In addressing this issue, however, the Secretariat exercises caution.

First of all, it is cognisant of self-fulfilling prophecies. If OPEC were to suggest a possible future price movement, in terms of magnitude and/or direction, then, quick as lightning, the market could react to this, exaggerating the forecast trend and fuelling volatility, especially in the present period of heavy speculation. The problem with speculation is that it is redolent of short-termism and runs counter to the general desire for, and OPEC’s express commitment to, longer-term stability. Therefore the Secretariat has to be very careful about making price forecasts.

Also, the history of oil price forecasting is a chequered one. A quarter of a century ago, some acclaimed international analysts were predicting crude oil prices of US $100 a barrel by the year 2000. Instead, prices collapsed below $10/b in the mid-1980s, less than half a decade later. Even today’s record levels are well below three-quarters of the way towards the $100/b mark — and that is in nominal terms. In real terms, today’s record prices would have equated to around $30/b in 1980, taking into account inflation and exchange rate movements.

For the shorter term, who can seriously claim to have predicted the price rises of the past couple of years? Indeed, the 150-year history of the modern petroleum industry is full of examples of price movements well out of line with expectations.

A more academic approach to assessing future price trends is scenario-building; but, because this must be governed by carefully defined parameters, this cannot provide the instant sound-bites on prices that are usually required by the media or the man in the street.

Thus, in publicly addressing the issue of future oil price trends, OPEC prefers to take a different approach altogether and to place the emphasis on creating the market conditions that are conducive to stability, with prices acceptable to producers and consumers alike. Its market agreements are drawn up with this in mind and are based on a very careful examination of the prevailing outlook.

OPEC is very much aware that the more prices are out of line with demand and supply fundamentals, the more likely they are to lead to increased volatility, and this can be damaging to all the players in the market.

However, the impact of OPEC’s measures varies according to the market conditions. Throughout the present volatile conditions, OPEC has ensured that the market has remained well-supplied with crude, as well as accelerating plans to increase production capacity, so as to help cater for the continued rise in demand forecast for the coming years. But, since other factors have been primarily responsible for the recent price rises, OPEC’s influence has been limited.

To address some of these non-fundamental factors, OPEC has in recent years intensified efforts on dialogue with some of the key players in the industry. We believe that with better understanding and appreciation of the fears and yearnings of the various stakeholders, a more solid basis for market stability will be established.

This Commentary is taken from the July-August 2006 edition of the OPEC Bulletin, which can be downloaded free of charge in PDF format from the OPEC website.

OPEC Bulletin (July-August 2006)

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