Thoughts on uncontrollable runaway oil price

08:46, December 27, 2007

The crude facts about the crude oil could shake the average American's faith in cars. The car-worshipping nation has recently been stripped of its dream of car ownership because of the skyrocketing oil price. "They ripped me off driving to work. Forty dollars was enough to fill the tank before, but now it costs you 60: up by 1/3," an American driver complained.

In France, nearly half of citizens have turned to public transportation. Ordinary people living in these developed countries that consume large amounts of energy have no choice but to abandon their cars when oil prices soar uncontrollably like a runaway horse. The price shot up to 99.29 U.S dollars per barrel on November 21, 2007.

While energy consuming giants groan, oil producing countries beam with satisfaction: "we are in want of everything but oil." When the world focused on this scenario: What if the oil price jumped to 100USD/barrel? Saudi Arabians were cheering for ‘"a happy and easy life."

In the face of such a contrast, we could not help but wonder: What on earth has caused the widening price gap? What has driven the average cost of 10 US dollars/ barrel to increase 10 times?

Root cause: uneven supply and demand

Who is responsible for inflation in the oil price? Thus far, a consensus among oil producers and consumers has been impossible to reach. OPEC placed the blame on oil speculation, to which the other side responded by saying the true cause lies in the tight oil supply.

Guan Qingyou, researcher at the National Conditions Research Center at Tsinghua University, informed People's Daily that the backdrop of oil market dating bulls can be traced back to 2001, when the global economy first flourished. And it has been snowballing ever since. Such rapid economic growth would ultimately result in an ever-growing demand for oil.

The report released in October by the International Energy Agency (IER) indicated that the world's daily average demand for crude oil this year was estimated to be 85.9 million barrels, up 1.5 percent over last year. Next year, the demand will climb to 88 million barrels, 2.4 percent higher than this year. In the mid- and long-term, the world's daily demand for oil will be growing year-on-year, and will hit 98 million barrels in 2015.

In the next five years, the IER pointed out, the world will experience a serious crisis in oil supply which could result in a record high boost in price.

Devaluation of USD should take the blame

The devaluation of the US dollar appears as the "black hand" in the oil price hike.
Since the sub-prime mortgage crisis broke out in the U.S this August and delivered a harsh blow to the US financial system that extended throughout the whole world; the US Federal Reserve Agency has brought down the interest rate three consecutive times, sending the US dollar spiraling and its exchange rate for euro into an abyss. The parity rate of other major western currencies also plummeted.

The fluctuation in the US dollar would inevitably impose an impact on oil price because of the dollar valuation system adopted in the oil market.
According to expert analysis, assuming wide-ranging dollar devaluation was not to reverse, the oil price would rise to its full extent.

Speculations and profiteering exacerbate the situation

In the backdrop of uneven demand and supply and devalued dollars, the speculators instead flood into the futures market seeking huge profits. Oil, in their eyes, is an irreplaceable profiteering product, and they would waste no time in driving up the oil price should the consumers' desire for oil coincide with the short-term effects of a breaking event on the oil market.

Presently, the oil futures market runs so rampant that transactions have doubled the actual demand. The hedge fund remains active in the futures market – which reportedly amounts to 1.8 trillion US dollars – making the international oil price a highly sensitive case.

Geopolitical considerations

At the Third OPEC Summit, President Hugo.Chavez of Venezuela declared: "if US led an attack on Iran, the oil price could balloon up to 200 US dollars per barrel." It was then taken as an overstatement; yet it mirrors a hidden force in the oil market pricing system—geopolitics, whose precariousness will also force up the oil price.

For the time being, the clash between the US and Iran escalates, and a confrontation is at hand. As a popular Iranian slogan goes, the US would be squeezed dry of every last drop of oil if it launched a raid on Iran.
How long will the oil price hike continue? It seems to be an outlandish question going beyond everyone's expectations. The "butterfly effect" in the oil market has taken shape, which could, without prompt guidance and adjustment, cascade downwards into "oil tornadoes."

By People's Daily Online

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