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Thursday, December 14, 2017

Speculation adding to oil price increase

Apart from the tight supply/demand balance, political tensions and uncertainties, increasing US and Chinese oil demand and tight stocks, speculation is adding to the recent oil price increase. According to the Financial Times, US crude oil futures have reached their highest level in 21 years. Oil has become the market of choice for speculators in recent months with total outstanding crude-related energy contracts on the New York Mercantile Exchange equating to an underlying 1 billion barrels or about 4 and a half months of global consumption.
The graph below shows the daily spot price for Brent Blend in the period 1999 to date.



The International Energy Agency (IEA) notes that oil prices remain an important macro-economic variable despite oil intensity having declined. According to their modelling results, global GDP growth might have been at least 0.5% higher in the last two or three years had prices remained at mid-2001 levels. Oil importing developing countries would generally suffer most as their economies are more oil-intensive and less able to weather the financial turmoil wrought by higher oil-import costs. 
The general economic background to the current run-up in prices is significantly different to previous oil-price shocks, all of which coincided with an economic boom when economies were already overheating. Prices are now rising in a situation of tentative economic revival, excess capacity and low inflation. Firms are less able to pass on higher energy-input costs in higher prices of goods and services because of strong competition in wholesale and retail markets. As a result, higher oil prices have so far eroded profits more than they have pushed up inflation. A weaker dollar since 2002 has also partly offset the impact of higher oil prices in many countries, especially in the Euro zone and Japan.
Adjusting for inflation, historically oil prices were much higher in the period 1974 to 1985. The graph below shows the development in nominal and real oil prices in the period 1970 to 2004.