By Michael Economides
In 2005 with oil flirting with the then unthinkable $60, I predicted on CNBC that the price of oil was inexorably moving toward $100. Others at the time were talking about pulling back to a more "logical" $40. The price of oil never really went down, steadily climbing, and earlier this year (yes it may seem a lot longer ago) hit the century mark and then proceeded to climb to almost $150.
But in September the credit crisis hit which in October became a tsunami that surprised all, including me. Oil dropped below $50, languishing around that price.
In vain the Organization of the Petroleum Exporting Countries (OPEC) has tried to stem the tide by announcing a reduction in production quotas. The market shrugged it off. The price of oil continued to decline.
The price gyrations should for ever put to rest what some, including distinguished economists, have unabashedly written about or said on international TV. There is no linear relationship between supply and demand. This is a margin business where 1 percent of over or under supply can bring havoc to the oil price with 50 percent fluctuations down or up.
There was also never a real rationale for $100 plus oil. If only I were the king-philosopher, running the world oil business, with proper reservoir management. But this price would be just about the statistician's definition of well-being: your head is in the oven, your feet are on ice and on the average you feel comfortable. There was no way that such a price could be achieved.
Here are the reasons. For the better part of a decade, the price of oil was not logical, its fluctuations almost entirely driven by headlines, most of them geopolitical in nature. Energy-producing nations had no interest to "manage" oil production or to optimize their resources by enlisting the best and the brightest technology and companies in the world. Their main motivation was to push the price up as much as possible at minimum work.
Price hikes seemed to work for quite a while. Major multinational oil companies were booted or eased out and national oil companies took control. It was not helpful to the traditional consuming countries that new ones were having huge, gargantuan energy appetites.
Nor was it constructive that the United States, accused of going to war for oil, got stalled in the quagmire of Iraq. That country that can demonstrably deliver 6 million barrels per day has vegetated right at 2 million, along with all the suffering, brutality and uncertainty that war always brings.
But the economic crisis apparently trumped geopolitical headlines. In late October the market shrugged off a stunning revelation by the International Energy Agency. In 2008, world oil production fell by a jaw-dropping 9.1 percent. Had the oil price trends of August and September not been interrupted by the dire economic headlines, this drop in oil production, delegated to page 17 of major newspapers, would probably shoot the price to $200.
But surely nobody should sit back and think that $50 per barrel is here to stay. The same reasons that brought $100 are still in force. Saudi Arabia can play a world regulator because it can. That in itself is a tantalizing question and a role that Saudi Arabia played before, during the Ronald Reagan Administration, when over-production at his instigation hit the former Soviet Union.
On the other hand, $50 is unsustainable. At that price nobody has to do anything drastic, just don't drill a few wells, don't stimulate others; let the natural decline take over.
Recessions go away and I am one of those who believe this will not last as long as some masochists would like it to be. One of the reasons is the inertia of China and the infectious optimism of Americans. Imagine the horror of horrors. China is predicted to have "only" a 9 percent growth in 2009, a figure that every other country would die for.
The world has become an energy-hungry place where energy consumption and wealth have never been more intimately connected. Oil prices will bounce back and the old adage "the higher they get the harder they fall" has a direct retort in oil prices. The harder they fall the higher they get: $50 now onto $200.
The author is a professor at the University of Houston and the Editor-in-Chief of the Energy Tribune
(China Daily November 25, 2008)