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Thursday, Aug. 2, 2007

Expect oil to hit $100 a barrel and beyond


LONDON — Nine of the last 10 serious downturns in the world economy followed a spike in the price of oil, and we are heading for another spike, with oil back up near the peak of $78.40 a barrel that it reached almost exactly a year ago.

A record number of options contracts are now being sold that entitle customers to buy oil in the future at $100 a barrel. That tells you where the inside players think the price of oil is heading, since those options will only be of value if the price were actually above $100 a barrel.

The spike at $78.40 in July 2006 didn't cause a recession, so why should this one? Indeed, why would even $100 a barrel cause a global economic crisis, given that $100 today is only worth about the same in most other currencies as $78.40 was a year ago?

Oil sales are almost all denominated in dollars, which are worth almost a third less in euros, pounds or yen than they were two years ago, so the countries of the Organization of Petroleum Exporting Countries (OPEC), are not rolling in sudden wealth. The oil exporters spend most of their income in other currencies, so from their point of view the recent surge in the oil price only restores the purchasing power that they lost over the past two years due to the dollar's slide.

More importantly, most of the big importers of oil in the industrialized world are not really paying much more for oil than they were two years ago. The rising dollar price has been largely canceled out by the fall in the value of the dollar, so it's not really busting their budgets.

American consumers are feeling victimized, but they get little sympathy in the Middle Eastern countries that dominate OPEC, as most of these governments believe that U.S. President George W. Bush's invasion of Iraq has made their neighborhood a far more dangerous place. OPEC is not going to pump more oil out of gratitude for Bush's policies.

What is really significant about the current surge in the price of oil is that it has not been driven by some apparently apocalyptic crisis like the Arab-Israeli war of 1973 or the Iranian revolution. (Neither event was actually all that apocalyptic, in retrospect, but the markets don't do long-term perspectives.)

We are three-quarters of the way to $100 a barrel without a crisis, driven simply by stagnant production and soaring demand in the big Asian economies. We could get the rest of the way on a rumor, and the price rise would not necessarily stop there.

The truly significant change in the situation is the stagnation of supply, not the rise in demand. New oil fields are much smaller than discoveries in the previous generation (the last really big oil domain to be developed was the North Sea in the 1970s), and they tend to be in much more remote places.

The number of new deep-sea drilling rigs now under construction is almost equal to the total number that currently exist in the world (70). When you have to look for new oil at depths of over 1,500 meters under the sea, or coax it out of the tar-sands of northern Alberta by equally expensive techniques, the era of plentiful cheap oil is definitely over.

OPEC is squeezing supply a bit to keep the price high, but its members are pumping close to capacity and only Saudi Arabia is putting in major new production capability. Non-OPEC oil output is predicted to stay flat for the next five years. It may not really be "peak oil" yet, but at the least we are seeing a lot of phenomena that mimic that time.

If the American mortgage crisis does not tumble the global economy into a recession, Asian demand will go on growing until the oil price does it — at $100 a barrel if we're lucky, or via a detour through $200 a barrel if U.S. Vice President Dick Cheney decides to attack Iran.

Gwynne Dyer is a London-based independent journalist whose articles are published in 45 countries.


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