With oil and gasoline prices surging across the globe, all eyes are on the OPEC meeting today in Beirut. What will OPEC do?
Recent OPEC announcements about cartel production quotas have little relationship to decisions made by OPEC members. Last March, for instance, OPEC announced a 4.1 percent cut in oil production, causing great consternation throughout the industrialized world. But no such cut ever materialized. Promises to increase production likewise may or may not be realized - we'll have to wait and see.
Regardless, the current oil price increase is not the result of OPEC production restraint. World oil production has actually increased by 7.6 percent from 2002 through February 2004 (the latest date for which we have reliable data), with OPEC production up 10 percent over that same period.
Unlike the oil price spikes of 1973, 1979, and 1990, this is a demand-induced price shock. Global economic recovery has stepped-up consumer appetite for oil and nowhere has this appetite grown as fast as it has in China.
The good news, then, is that the oil price explosion is a symptom of the surprising strength of the global economy. The bad news is the uncertainty that surrounds producers' response to the demand growth.
Most observers believe that the only producer that can increase output in the short run now is Saudi Arabia. Whether they will respond to current prices by increasing production and whether that increase will ease current prices depends on what market participants believe about future prices.
Ironically, the more certain that today's prices are stable and here to stay, the quicker that they will disappear. The less certain that today's prices are here to stay, the slower the market will respond with investment in new capacity and what oil is produced is as likely to be held in inventory. Unfortunately, it's unclear whether investors have come to a conclusion about how long these prices might last.
Even if the primary factor in the current growth in demand is actual consumption because of economic growth, an important secondary factor is simple fear. Because little excess supply capacity exists and inventories are low, any supply disruption would increase prices even further. And it's not hard to spin such a scenario. Iraqi insurgents could perhaps shut down some oil production in that country, which is now slightly below pre-war levels. Al Qaeda terrorists could step-up their attacks on Saudi oil production and transportation assets. Revolutionary violence could breakout in Iran. The notoriously unstable Venezuelan President Hugo Chavez could go nuts. Labor unrest might break out almost anywhere that oil is found in large volumes.
Accordingly, speculators are buying and holding oil in the hopes that they can cash it in when prices explode in the future. Private and public inventories around the world are likewise being built up as quickly as possible. The upshot is that both speculators and stockpile owners are holding oil for the future, increasing world oil prices even higher in the process.
If such a supply interruption occurs, we should (but probably won't) thank those oft-maligned speculators for their foresight in saving some of that black gold for a rainy day. If we don't, we'll probably curse them (but probably shouldn't) as greedy market parasites who fed a price bubble that proved ruinous to consumers.
Regardless, once oil inventories are built back up again, the "fear premium" will likely dissipate somewhat. But until new oil production investment begins to bear fruit, we might have to live with relatively high oil prices for some time to come - and with the threat of a truly epic price spike that could make today's gasoline prices look tame by comparison.
But then again, we might not. The Chinese economy could crash. The global economy might cool off. Producers may be able to deliver new oil to the market faster than anyone anticipated. High prices may encourage so much conservation that demand plummets faster than anyone thought possible. The Saudis may have more capacity in reserve than anyone realized. Speculators might decide their investment in expensive oil is a bad bet and crude prices could collapse almost overnight.
Knowing how markets work is not the same as being able to predict the future regarding supply and demand. How high prices will go, how long they might stay there, and when they'll come down is anyone's guess.