What is the Oil PriceTelling Us?

Like the mining supply of Gold, oil output is not rising with higher prices...

WHY IS THE SUPPLY of oil not rising with higher prices, asks Julian Phillip of GoldForecaster.com in the second part of his essay Gold & Oil...

   On the supply side, certain opaque realities are often overlooked, but they clearly have to be faced.

  
Non-Opec oil producers are unable to push up oil production as fast as incremental demand is expanding. Old oil fields are declining while new ones are not coming on stream fast enough. This situation will not change in the next few years, unless new oil fields are found.

  
Can Opec fill the gap? The oil cartel has a share of global oil supply of 45% at the moment. While it is saying there is plenty of oil around, its underlying attitude to market prices has changed dramatically to the detriment of lower prices.

  
When seen through their eyes, oil is in good supply if one takes out of the formula speculators and investors trading positions they have no intention of consuming. This could be in the region of 35% of oil supply in total. So why should Opec. support such speculation? Shouldn’t the authorities takes these out of the equation so oil can be used properly?

  
Opec has not vigorously pursued replacing used oilfields because of the risk and expense involved. (What if prices went so low that their investment returns did not cover these extra costs?) Little exploration was undertaken. In Iraq – with 40% of Opec’s reserves still undeveloped – many expected the United States to accelerate oil production so that Washington would have a firm grip on global oil supply and could ensure low oil prices would persist into the future. Why did this not happen? We know that answer, as daily reports from Iraq make patently clear.

  
Oil supply is clearly not keeping pace with global oil demand, as reflected in a steadily shrinking buffer inventory of crude and refined products. Weekly rises in inventories in the States are a short-term changing part of the picture. What has happened to change the oil market at its fundamental level is the change in attitude of Opec.

  
In the past, Opec accommodated its customers on the price front ensuring supplies supported lower prices, believing demand would drop if prices rose too high. Then the Middle East started to develop itself and the need to increase its wealth on the back of this wasting asset came to the fore in their pricing and supply equations. They also realized that the oil they had was just not enough to go around and was wasting away as supplies were sucked out of the ground.

  
Future generations had to be taken into account, so getting as much money for the oil as possible became the target, as it now is with non-Opec members too. Surely this is market-oriented capitalism at it best? And the proof of this pudding will be in its eating, for we are moving to a place where not only is the entire world economy being threatened by present and future insufficient supplies of oil, there is no way out of the vice-like squeeze of oil prices!

  
So the underlying attitude of oil producers going forward is one that will act to maximize income from oil, irrespective of the effects on the global economy.

  
At $20 per barrel, oil producers received $600bn in annual revenue. At $120 per barrel this is $3.6 trillion. Oh, and there’s much more capacity for Western economies to bear higher prices – and for Middle Eastern oil kingdoms to benefit from them – as oil revenues as a share of global GDP is only at 65% of the 1980s level. That’s why $200 a barrel is foreseeable!

  
And don’t think market forces are sufficient to drop demand and pull prices down with it. Oil fuels the global engines and nothing else will. In such an environment the value of paper currencies will spiral down as the pace of the oil price rises over time, leading investors to hold Gold and silver, which will rise in value as the value of unlimited and inflatable currencies fall.

  
But what is the collateral damage we will see because of high oil prices? To get the entire report please subscribe to GoldForecaster.com...