The price of Brent Crude | Brussels Blog

The price of Brent Crude

posted by on 22nd Mar 2011
22nd,Mar

Recently, the price of Brent Crude Oil has touched $115 a barrel and it is continuing to rise. As a consequence, we have been entertained on a more or less daily basis with dire warnings issued by the great and the good, as to the negative effect that rising oil prices will have on the “global economic recovery”. Frankly, given that all of the major economic recessions that have occurred since 1973 have been preceded by a spike in the price of oil, this is not an insight that goes beyond the cerebral capacity of Homer Simpson. It is however, within the comfortable, conventional narrative, that is, that once a few local problems have been sorted out it will be back to business as usual. So, rather than question the robustness of an economic system based on a finite resource, someone has to be held to account. Who is to blame? There are a number of candidates.

First and foremost there is of course, the Libyan leader Colonel Gaddafi. He fits the bill as pantomime villain rather well. He a dictator with the usual credentials, vast wealth, a taste for torture, badly-dyed hair and, a nice touch, a wardrobe that appears to have been co-ordinated by Widow Twankey. He also has the ultimate bonkers-tyrant accolade of being on chummy terms with our former Prime Minister, Mr. Blair.

Second, there are those shadowy hate-figures from the world of the stock markets, the speculators. Now, as far as they are concerned, I am confused. To my mind, blaming speculators for speculating on the price of oil is akin to going to a Chelsea v Man. United F.A. Cup Final at Wembley and saying something like this-
“Ooh why are they kicking that nice new ball around getting it dirty like that. I mean why can’t they all just sit down so we can check-out their tattoos and read the adverts on their strip?”

Speculators speculate. They do not however, do so on a whim. Generally, they work at the edge of the relationship between supply and demand. Generally, they know the price of things, (if not their value).There have of course, been spectacular failures. For example, in the seventeenth century during the period known as “Tulip Mania” the markets in the Netherlands pushed the price of tulip bulbs to extraordinary and quite unjustified highs. This however, was a commodity which had only recently been introduced onto the market. When the supply and demand relationship became better understood, the madness passed and the price crashed.

Oil on the other hand, has been traded in large quantities for over a hundred years. When the price goes up or down there are identifiable reasons for the movement. Markets, as we are often reminded, are swayed by emotion. The emotion in question is a combination of fear and greed, fear of the loss of money and the greed for more, the yin and yang of capitalism. So, when the price is going up in the way that it has been, the obvious question to ask is this. Of what are the markets afraid? The short answer to that question is that there is a palpable fear that demand will outstrip supply. The fear is that there is a shortage of oil. So, is Colonel Gaddafi really to blame? The answer to that question is yes and no.

Libya usually produces 1.6 million barrels of oil a day. That is just two percent of the world total. It is however, high quality, light, sweet oil of the kind that is ideal for the production of low sulphur diesel fuel. One barrel of this oil is worth three of the heavier, more”sour” grades that are found in other parts of the world. So when Libya goes off-stream, a substantial replacement has to be found. For that the world looks to the so called “swing producers”, that is to say countries who in normal times produce less than the amount of which they are capable. These countries have the ability to increase their production to a significantly higher level at very short notice. When there is a deficiency in the supply chain, they can fill it. That is the theory.
The most significant swing producer is a hereditary autocracy in the Arabian desert. It takes its name from its rulers, a monarchy that brooks no political dissent. To enable it to rule, the monarchy relies on the support of an Islamic sect, The Wahabi, that is, because of its extreme views, an anathema to most Moslems living in other parts of the world. In this country women are not allowed to drive cars nor to go out of their homes unaccompanied by a family member. Adultery is punishable by death. Public executions are held in which culprits are beheaded with a sword. This country supplied eleven of the terrorists responsible for the destruction of the Twin Towers. It is the home of Osama bin Laden. It is the firmest ally of the West in the region. American presidents bow to its monarch. It is the fiefdom of the bin Saud family. It is of course Saudi Arabia.

It is no exaggeration to say that Saudi Arabia holds the economy of the world in its hands. It is by far the world’s largest single source of oil and has the worlds largest field. Were it to suffer political or social turmoil of the kind that has arisen in Tunisia, Egypt and Libya the price of oil would go above $200. It is for this reason that no one dares to object to the Saudi intervention in Bahrain. It matters not that in that country, 70% of the population are Shia but are ruled undemocratically by a Sunni monarchy. We, the West, are prepared to invoke the liberal intervention policy so spectacularly discredited in Iraq, to bomb Libya but would not for one minute dream of giving support to the “rebels” in Bahrain. The Saudis would not like it.

All however, is not well with the Saudi oil industry. Two years ago it announced its intention to increase production. At vast expense it re-opened the Khurais field. This field was known but had not been fully exploited. There was a reason for that. It did not and does not produce light, sweet crude. It is not an easy field to exploit. The objective was to increase oil production. Guess what, there has been no significant increase. There is a reason for that too. The vast oil wealth of Saudi Arabia is beginning to run dry. The northern part of the massive Ghawar field that produces cheap, light, sweet crude is past its peak. Of course there are massive reserves remaining, but they are dwindling. In fact Saudi Arabia’s production has not increased significantly since the 1970’s and 80’s the fact notwithstanding that it has spent billions of dollars in an attempt to increase capacity. It is running to keep still.

The great and the good who warn us of the danger to the world economy of a spike in oil prices are wont in the next breath to reassure us that there is plenty of spare capacity in Saudi Arabia. They are wrong. There is no slack which can be taken up when the supply is constricted. The USA has recently mooted making oil available from the strategic petroleum reserve. It is obvious that were the, so called, swing producers in a position to make up for the loss of Libya’s modest contribution to world supplies they would do and there would be no need to contemplate calling on emergency supplies.

It is not tyrants or speculators who are inexorably pushing up the price of oil. It is we who are doing so. We need it but the earth is beginning to begrudge us its supply.

Robert Urquhart Collins

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