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I had lunch earlier this week with a very clever economist who pointed out that economics really isn’t that hard. To be good at it, he said, you need only understand two things – supply and demand. Once you’ve got those sorted it isn’t that hard to figure the rest out. How odd it is then that when it comes to oil so many strategists and politicians seem to find grasping the supply-demand equation so very difficult. Why for example do they insist on comparing today’s rising oil price with the oil shocks of the 1970s?
Back then the price changes were supply-related. Demand for oil didn’t change that much over the period (except for to fall as high prices hit economic growth) and it certainly didn’t outrun the supply that was potentially available. However, thanks to wars and stroppy suppliers, there were huge supply disruptions. These pushed the price of oil up suddenly and sharply and, as we are constantly reminded by the back to the 70s crowd, caused no end of trouble.
But this time the rising oil price isn’t so much about supply. We may worry about the security of oil supplies, but in truth they really haven’t been much disrupted of late (even the Katrina effect has proved pretty short lived) and right now no one is deliberately withholding oil from anyone else. In fact most OPEC countries are running close to full capacity: even Saudi – whatever it may claim about its production capability – probably has the spigots turned about as far as they can go. Overall supply is flat to slightly rising.
However demand is a different matter altogether: it is rising relentlessly. Demand for oil all over the west is still rising (up 15% in the US between 1994 and 2004 for example) but in the developing world it is soaring. China is the most well known example – note that it has doubled its oil usage over the last decade and now consumes 30% of the world’s oil. But this isn’t just about China: oil consumption is rising fast in India, Vietnam, Thailand, Russia and even in the Middle East itself. And unless these countries just stop growing that isn’t going to change.
So, given this, let’s look at Gordon Brown’s bemusing comments on oil prices last Tuesday. High oil prices are a global problem, he said, and as such they require “global solutions.” I can’t imagine what he means. We already know that the world’s suppliers are producing as much as they can so he can’t possibly think that his call for action will suddenly result in more oil being produced. And we also already know that the rise of global demand is unstoppable, so what can he expect to be done about that? Will he be insisting that those pesky Chinese stop it with the growth stuff? That the Vietnamese forsake their dreams of car ownership and stick with bicycles (they look nicer in travel brochures anyway)? Or perhaps that the Indians promise not to produce any textiles derived from petroleum products ever again?
Mr Brown is well known to spend parts of his time in fantasyland but it’s high time he joined the rest of us in reality land. He’s right in thinking that oil is a global problem – it is – but it is also a global market, something that makes it utterly uncontrollable: the price will be determined by supply and demand and that is that. And supply (not rising) and demand (rising) tell us that the oil price will stay high and that the petrol price will too. Global solutions? Short to medium term there aren’t any.
If you are holding oil-related shares in your portfolio as a long term investment all this means you should hang on to them. That said, it might not be the right time to top up your holdings. Mr Brown is (clearly) more a politician than an economist and while he is unlikely to bow to demands for the fuel tax to be cut there is every chance that he will go for a windfall tax on the profits of the big oil companies. Not only could he really do with the money, but he also knows that the happiness of any group of people is relative. We hate paying a lot of money for petrol but we hate it even more when we know that someone’s making hordes of money out of it. So if we feel they’re being punished by having some of that cash taken away, even if it makes no difference whatsoever to pump prices, we might not mind so much - and that would make Brown’s life much easier.
Now to my mind a windfall tax would be a whopper of a mistake. The main reason that there been so little spending on exploration and refining capacity around the world in the last two decades is because the oil companies have been making such rubbish profits that they have had little incentive to invest in new projects. Now they’ve got those profits, surely it would be better that they got on with finding and refining more oil than that they were forced to hand the fruits of their rare good fortune over to the Chancellor. I’d certainly think so, but I’d hang back from the oil sector until it’s clearer what the politicians think.
First published in The Sunday Times 18/09/2005
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Commodities
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Merryn Somerset Webb
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