Whether or not the price of oil has peaked, hand-wringing on its fate has reached a frenzy. Writing in the Financial Times (FT), Daniel Yergin, the Pulitzer Prize-winning author of Prize: The Quest for Oil, Money and Power, declares that oil has reached a turning point. He deftly sidesteps the question of predicting the price of oil—in the near term or long term. Importantly, he observes that the costs of drilling, labour and rigs have all gone up. The world faces inflation not just in the relative price of oil.
Yet, the focus on oil prices and the near-total indifference to real policy sins is now a global obsession. Predictions of an imminent end to oil price increases are flowing thick and fast. Usually, things happen unexpectedly, just as the rise of oil price itself to present levels and not when everyone is predicting it.
John Mauldin presents a whole set of arguments to show that speculation might indeed be behind the spike in oil price (“The geopolitics of 130 oil”, John Mauldin’s Outside the Box, 29 May edition).
In his weekly market commentary, John Hussman finds the contango in crude oil futures as heralding a big slump, just as it did in 2006 when the price of oil dropped from around $80 to $55 per barrel. He has exited his position in crude oil and has reduced his position in precious metals to 2%.
Then, there is the testimony of one Michael Master to the US Congress on the oil price spike. He has said that it is caused by index investors. You can read his full testimony here: http://hsgac.senate.gov/public/_files/052008Masters.pdf
It is not clear if these prognostications confuse wishful thinking for forecasts, for buried within its crevices, The Wall Street Journal carried an article on the oil producers shipping less crude than before. This article refers to the rising consumption in Saudi Arabia and the rapidly declining export from Mexico. It is an interesting read and manages to end on an optimistic note, concluding somewhat inexplicably that prices would fall.
Talking of inexplicable conclusions that did not flow from the discussions that preceded it, a research paper (Crude Awakening: Behind the Surge in Oil Prices, Economic Letter, Vol. 3, No. 5, May 2008) by the Federal Reserve Bank of Dallas does the same thing. It argues, explains and convinces us that oil prices are justifiably high. Then suddenly it concludes that sustaining triple-digit prices would be difficult.
Let me add my voice to the noise. I think the US does not want to see the price of oil to drop so much that it angers the sheikhs in the Arabian sands to the extent that they stop writing cheques for bankrupt Wall Street institutions.
Another article in FT (“US to woo Gulf investors”, 29 May) confirms the US’ forked tongue on the matter of the oil price. The first line is a gem: “Hank Paulson, the US treasury secretary, will invite oil producers to invest their petrodollars in the US while urging them to take steps to curb the price of oil in the medium term on a tour of the Gulf that begins on Friday.”
Once the US has finished recapitalizing its financial institutions, it would not be averse to seeing the oil price collapse. In fact, it might even actively conspire to bring that eventuality about.
An important bonus is that if the price of oil continues to remain high, it would also put paid to any fledgling ambition of China (or even the distant India) to overtake the US. At the very least, it would push the time frame out by a few years and, with some luck, a few decades.
Credit Suisse’s Dong Tao wrote in its Emerging Markets Economics Daily (30 May) that Xu Xianchun, deputy director of China’s National Bureau of Statistics, has suggested that inflation might not peak until 2009.
The longer the oil stays elevated, the longer the persistence of inflation in China and the greater the policy challenge. In the meantime, more money would keep coming into China in search of yuan appreciation. China’s policy dilemma would become more acute by the day.
Thus, high oil price serves to rub a few noses in Asia into the sand lest they get ideas of dominating the world economic and financial landscape and discourse with their stockpile of reserves.
So, for what it is worth (you might be better off tossing a coin to decide), my forecast is that the price of crude oil would drop to about $110-115 or so. That is about it.
It would then go back to $150, to drive one final nail into Asian economies, shower riches on West Asia and recapitalize the US. Then, once it has done its damage, the missile would be allowed to extinguish itself or burn itself out (pun intended).
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org