Economic focus

The Importance of Black Gold

If I were to point out that oil had all but doubled in price in less than a year, you might be a little surprised.

Yet in June last year it had fallen to within a whisker of $40 a barrel, while last May it flirted – admittedly briefly – with $80. True, you may well have noticed that the price of fuel at the pump has been steadily rising in recent months, but often this is blamed on the weakness of sterling. With the US dollar rebounding of late, petrol is bound to cost us more, regardless of what the oil price is doing on world markets.

Oil has, though, enjoyed something of a resurgence in recent months. In part this can be attributed to continuing buoyancy in the global economy, but supply restrictions have also played their part. The Venezuelan oil production industry, once a serious contributor to global consumption, is in disarray, while a shadow has been cast over Iran’s likely output with America withdrawing from the international nuclear deal and threatening fresh sanctions.

In the shorter term the price shied away from recent peaks as belief grew that both Russia and the OPEC producers might lift the caps on supply presently imposed. Generally this was greeted favourably as it eased some of the inflationary pressures that had been building and thus should be good for economic growth as costs potentially reduced. But is oil still the crucial element in economic wellbeing that once it was, given the move towards cleaner energy sources that seems to be gaining momentum amongst important consumers like China?

There is nothing straightforward about the oil market. It is estimated that for every barrel of oil actually consumed, ten barrels change hands on the various exchanges that exist to facilitate trading. Oil is such an important component in so many industries that many companies buy and sell their anticipated needs simply to allow a degree of certainty in their pricing policies. Airlines are a case in point, with forward purchasing a regular method of establishing likely fuel costs. Because the oil price is sensitive to geo-political risk, as well as simple supply and demand, trying to take the guess work out of a major cost element is no more than prudent.

With greater fuel efficiency and increasing concern over the negative effect fossil fuels have on our environment, you might consider demand for this commodity to be falling. Make no mistake, though, the rate of consumption of oil and oil based products may not be growing as fast as it once did, but grow it does. Unsurprisingly, the United States is the largest single user of the black stuff, consuming an estimated 19 million barrels of crude oil a day. China fills the second slot, though its total consumption is only around 60% of that of the US. And Japan, which lies third, consumes less than half that of China.

This says a great deal about why demand for oil is unlikely to fall, despite government initiatives to find greener solutions for transportation and heating problems. India consumes just a fifth of what America gets through, despite having a population more than three times greater. As so-called developing nations increase their prosperity, so their demand for oil seems set to rise. A decline in demand from the developed world will almost certainly be outweighed by more consumption from emerging countries.

As to what this might mean for the oil price going forward, this is altogether a more difficult call. Ten years ago, in the summer of 2008, the oil price seemed set to reach $150. The financial crisis that developed in the early autumn triggered a global recession and within six months of the peak, the price had collapsed to little more than $30. It did recover subsequently, but bear in mind that early in 2016, not much more than two years ago, the price actually fell below $30 a barrel. A robust global economy (the OECD recently reviewed its economic forecasts and concluded that world growth should “hover” around 4% for the current year, though this might mark the peak of the cycle) should keep demand high, but if OPEC steps up production, this would sort out current supply problems.

United States is the largest single user of the black stuff, consuming an estimated 19 million barrels of crude oil a day.

There have been many occasions in the past when attention has been drawn to the finite nature of our oil reserves, yet new discoveries and, indeed, new methods of extracting oil have proved that we are unlikely to run out any time soon. Oil still dominates energy production and in the end it seems more likely that it will be environmental concerns that drive efforts to find new energy sources rather than fears of dwindling stocks. Expect the price of oil to continue to play a major part in how we expect inflation and economic growth to develop for the foreseeable future.

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Kim Woolmer

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