Oil boom... and bust?

23 May 2008
Is the world running out of oil? Or are oil traders cashing in on temporary price hikes – creating a temporary bubble that will soon burst? Oscar Reyes looks at why the oil price is hitting record levels.
In Indonesia, thousands of people protested as the government cut fuel subsidies in response to sharply rising prices. In France, fishermen are blockading oil refineries. And in the United States, Ford is to cut production of its oil-hungry sports utility vehicles; while American Airlines has retired old planes and added a $15 surcharge to flight tickets. This week, oil prices hit record highs of $135 per barrel – which, even taking inflation into account, is higher than at the peak of the 1970s oil crisis. Is the world running out of oil? Or are oil traders cashing in on temporary price hikes – creating a temporary bubble that will soon burst? With oil prices reaching record highs, there is no shortage of explanations for the current boom. The latest surge came after the US government reported that its supplies of crude oil and petrol fell unexpectedly in the last week. Financial speculation was rife, with a $5 dollar price hike in a single day’s trading on Wednesday bearing all the hallmarks of a speculative bubble. The weak US currency was also a factor, as it makes it cheaper for holders of other currencies to buy oil - which is traditionally priced in dollars. In addition, many investors see commodities such as oil as a hedge against inflation and the falling dollar. But while some analysts consider that, in the short term, this bubble could burst, the fundamentals of oil supply and global politics make it more likely that the price of a barrel of crude will continue its upward trend. The International Energy Agency (IEA) last year reported that oil demand is likely to outpace rises in oil supply until at least 2012, generating significant shortfalls. The economic and consumer boom in the world's largest developing countries, particularly China and India, are one key factor. But this is accompanied by a pronounced slowdown in the expansion of global supply, due mainly to a dearth of new discoveries, which many analysts take a sign that the world is approaching peak oil - the moment in our history where supplies start to dwindle. This trend has been exacerbated by the unwillingness – and, to some extent, inability - of the oil cartel Opec to pump significantly more crude. Recurrent political disorder in key oil fields already in production – including Iraq and Nigeria – is a further factor. US aggression towards key oil producers, including Iraq, Venezuela and Iran – has made the markets nervous too, with the resulting spike in oil prices having a significant ‘blowback’ effect on the US economy itself. So what are the consequences of all this? The environmental impact is ambiguous. A cut in flights, and a decline in sales of gas guzzling 4x4 vehicles in the United States is good news for the planet. But price alone will not change the oil addition of Western consumers. And while oil-dependent companies are reporting losses, oil companies themselves are doing well – with the high price making it viable to invest in new “unconventional” oil sources, such as tar sands and deep-offshore fields. The impact on the US economy is more telling, however. With oil prices now over twice what they were a year ago, they are fuelling US inflation by making it more expensive to transport goods such as food. This, in turn, is helping to weaken the value of the dollar on international currency markets – which then inflates the price of oil itself in international trading. More fundamentally, though, the high oil price is weakening the US economy in the longer term by generating a huge balance-of-payments deficit. As the United States continues to feed its oil addiction, wealth is being transferred at a rapid rate to the economies of oil-producing nations.