Can oil sustain at $100+?

Abstract

Oil is the lifeblood of most economies and is needed to support the basic economic infrastructure. However, with prices more than doubling in the past year alone to an all time high of $144 a barrel, the impact is being felt acutely by consumers and businesses alike. The question that arises is whether the price rise will continue unabated and if yes, what can be done to control this price rise. Rising prices imply paying higher prices for personal and public transport. This is aggravated by the rise in general inflation which will likely follow a jump in transport and fuel costs across the board. In order to answer the question of whether the high oil prices will sustain, we ve looked at the various potential causes of the price rise. The first cause we looked at was supply and demand mismatch. We found that the demand has been growing steadily over the last few years. The supply on the other hand has stagnated at round 85 million barrels per day. However, the growth is demand has not been drastic enough to warrant a four-fold increase in prices over the last few years. When we looked at the supply and demand in tandem, we found that the supply has been playing catch-up with demand. There is indeed a very small gap between supply and demand. As far as oil goes, both the demand and the supply are inelastic. The implication of this is that a small change in demand can cause an imbalance in the supply-demand situation and cause prices to rise dramatically. We concluded that the supply and demand taken together could have an impact on the oil prices. We then looked at the prospect of speculation in the commodities markets causing this unprecedented rise in oil prices. We found that there was a sharp rise in prices in not just oil but in commodities across the board including wheat, metals etc. The reason was the emergence of a new breed of speculators in the market referred to as Index Speculators. They first emerged in 2002 after the equity market crash and have since grown to constitute as much as 40% of the speculator base. These speculators are different from traditional speculators in that they only make a bet on the prices going up. They keep accumulating futures contracts through rollover irrespective of the price of the commodity. They never sell. They just rollover their existing contracts to the next period. They have made massive investments in the commodities markets. The result has been a sharp rise in prices of commodities across the board. Having identified the causes, we then looked at what could prick the oil bubble. We found that there could be political reasons especially in the United States that would help increase investments in development of oil infrastructure (refineries, new oil offshore fields etc.). These new projects would then help in easing the supply crunch and be able to meet the growing demand in the medium to long term. This leads us to the conclusion that there is little chance of oil prices staying above $100.