Western governments heard a faint echo from the 1970s recently as the escalating cost of petrol contributed to higher inflation.
And with tension in the Middle East providing another reminder of life three decades ago, the message was that consumers can expect more of the same over the coming months.
The rising cost of energy over the past 18 months has come as a shock to almost every commentator. When a barrel of crude reached $40, it was assumed the price would halve. When it reached $50, the expectation was that the bubble would burst. Today, with crude above $65 in the futures markets, the talk is more cautious.
France’s Prime Minister, Dominique de Villepin, told a news conference this week that high prices were here to stay, and he called on oil firms to plough their sizeable profits into new plants.
”All the factors have come together for oil to remain expensive in the years and decades to come,” he said. ”Our refining capacity is saturated and cannot adequately cope with … demand.”
The lack of refining capacity has been one factor behind the upward trend in crude prices over the past two years. According to the experts, the lightning war against Saddam Hussein would make oil supplies more certain and help to keep the cost of energy low. Oil producers have certainly been in a mood to help consumers, with the Organisation of the Petroleum Exporting Countries cartel increasing its output quotas at regular intervals. But it has not been enough.
Demand, particularly from China and the United States, has been strong. There has not been the refining capacity to turn the crude into petroleum. And the prospect of further instability in the Middle East has meant the market is operating with a significant risk premium.
The upshot is that nobody knows where oil prices will go from here. One theory is that the end of the driving season in the US, coupled with a slight easing of the rapid pace of growth, means that crude prices are at, or close to, a peak. Another is that higher prices will provide an incentive for investment in the extra refining capacity demanded by De Villepin and that this, with a marked oil-induced slowdown in growth next year, will bring crude prices back to earth with a bump.
Interestingly, the markets take a less sanguine view. ”The futures curve suggests that the price of oil will remain around its current level for the next few years,” the Bank of England said in its quarterly Inflation Report last week. As the bank went on to say, the probability that the price of crude will follow the exact path suggested by the futures curve is very small. But the bets being laid by those speculating in oil futures tell a different story from some of the energy optimists. The data, according to the bank, ”suggest that financial markets believe that there is a greater chance of a large rise in the price of oil than a large fall. Currently, market participants judge that there is roughly a one-in-20 chance that oil prices will be $100 or higher in August 2006.”
A 5% chance of oil hitting $100 a barrel still represents long odds but Goldman Sachs, the biggest trader of energy derivatives, thinks it is a possibility. It put out a paper this year predicting a super-spike in oil prices to $105 a barrel. ”We believe oil markets may have entered the early stages of what we have referred to as a ‘super-spike’ period — a multi-year trading band of oil prices high enough to meaningfully reduce energy consumption and recreate a spare capacity cushion.” Only after that has happened does Goldman Sachs think lower energy prices will return.
Even though the market has paused for breath after last week’s heady rise, crude was still trading at about $66 a barrel in New York this week. It is already assumed that the $70 level will be tested at some point over the next few weeks, and the gloomier analysts find it easy to sketch out scenarios in which it goes much higher than that.
Dominic Bryant, oil analyst at BNP Paribas, said: ”One upside risk in the foreseeable future is another hurricane in the US, where some have been predicted … in October. Last year, hurricane Ivan in Mexico sent prices up by $6 a barrel.”
And if a hurricane could push up prices by $6 a barrel, a terrorist attack on an oil installation in Saudi Arabia would be likely to have an even more pronounced effect. Military action by the US against Iran would make the Goldman Sachs forecast highly plausible.
There are a couple of reasons for guarded optimism. Oil prices are high, but not as high in real terms as they were when Iran and Iraq went to war in 1980. Gerard Lyons, chief economist at Standard Chartered Bank, says there are three reasons why the impact of higher crude prices has been less marked than it was in the 1970s. First, some countries have used their financial resources to subsidise energy prices. Second, for most of the period when crude prices have been rising, the dollar has been going down. That has helped ameliorate the impact of dearer crude prices for the big importing nations because crude is priced in dollars. Finally, inflationary pressure is generally much weaker than it was three decades ago. — Â