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Oil prices to hit consuming, producing countries

JEDDAH — A paper prepared jointly by Saudi Arabia, the International Energy Agency, the International Energy Forum and the Organisation of Petroleum Exporting Countries was presented at the oil summit that was inaugurated by Custodian of the Two Holy Mosques King Abdullah bin Abdulaziz here on Sunday.

In the introduction, the paper said that spot and long-term oil futures prices had risen sharply in the recent past. This has been accompanied by an increase in price volatility.

However, despite such a price environment, global oil demand, although slower, continues to grow steadily, driven by non-OECD countries, where GDP growth is a much more important determinant of demand than price. This growth has been reinforced by the fact that oil demand is occurring basically in the price-inelastic sectors, such as transportation and petrochemicals, and is being influenced by the effects of subsidies and taxes.

This growth has also been accompanied by stronger linkages between the oil markets (as well as other commodity markets) and the financial markets, with activity in regulated and unregulated commodity exchanges also expanding.

It said that this price behaviour nevertheless impacts upon both consumers and producers, energy-intensive industries and the growth path of the world economy, even though this has, to date, been more resilient. However, the impact on the least-developed countries has been more pronounced.

The recent developments in the world oil market require concerted action from all parties — consumers, producers, the oil industry, the concerned intergovernmental organisations and all other interested parties — to work toward understanding the underlying reasons behind such developments, reducing uncertainties and taking the necessary actions to ensure the stability and sustainability of the energy system.

Following are excerpts from the paper: The causes of the recent oil price behaviour are multiple and complex. A host of factors has been contributing to it, and their exact weights are difficult to assess.

The following market fundamentals factors can be identified.

Lower crude oil spare capacity, relative to historic high levels, in the face of the projected rise in demand, has made markets wary of future supplies. Constrained upstream investment in some producing and consuming areas, due to different factors, such as access to technology, cost-inflation, shortages of skilled manpower, political and investment constraints, and demand predictability, has had an impact on such capacity. Limited refining capacity in oil product markets, due to a constrained refining investment, environmental standards, cost-inflation and stringent laws and regulations, resulting in poorer refining margins. This has been amplified by a mismatch between the quality of crude supply on the one hand and the demand for lighter products and tighter specifications on the other. In addition, while contributing to energy supply growth, biofuels are having a compounding effect on the refining industry in some regions.

Fears of supply disruptions, driven by geopolitical concerns, technical shut-ins, accidents and weather-related events, such as hurricanes.

Perceptions by some market participants of a limited oil resource base, lower growth in non-Opec supply and lower-than-normal levels of some product stocks.

The inclination of refineries to increase the distillate yields to meet demand and improve their margins has pushed up the price of distillates, as well as dragging up the price of crude oil.

In addition to the above market fundamentals factors, there have been other causes not necessarily related to the underlying demand and supply trends. Some of these can be identified as follows:

The increasing interaction between the oil market and the financial markets, making oil more of a financial asset than before.

The increase in the investment inflows from financial institutions, pension and hedge funds, and private equities, into the oil (and other commodities) futures and over-the-counter markets, due to the relative weakness in the value of the dollar and the lower returns on other assets.

Uncertainties about the monetary, fiscal, energy, investment, trade and environmental policies of consuming and producing countries.

Unrealistic assessments of the oil market situation and price projections by some entities.

While global demand has been growing for the past few years, as has been the case with global supply, all the above-mentioned factors and causes have played a part in increasing price levels and their volatility.

The paper said that oil price rises and the underlying volatility, if they continue without concerted action from all parties, will have an impact on the economies of the consuming and producing countries alike, as well as on the long-term stability of the international oil market and world economy. This could have the following consequences:

The adverse impact on economic growth, especially in the least-developed countries, through the energy/economy linkages.

Higher oil prices will affect heavily energy-intensive industries and the cost of transportation, and could result in higher inflation.

Higher oil prices will enhance the flow of investment into alternative fuels, which will put a floor to oil prices.

Continued oil price volatility gives confusing signals to investors in the upstream and downstream and delays required investment.

Higher oil prices and volatility have increased activity in the oil futures markets in a spiraling effect.

It said that the causes and consequences of the current oil price environment mentioned above call for a combination of efforts on the part of producing and consuming countries, the oil industry and all other interested parties. Taking into account their diverse national circumstances and priorities, as well as their shared interest in a stable global oil market and sustainable economic growth, the following proposals can be considered.

Spare capacity throughout the oil supply chain is important for the stability of the global oil market. Hence an appropriate increase in investment, both upstream and downstream, is necessary to ensure that the markets are supplied in a timely and adequate manner. Predictable energy and investment policies, as well as better access to technology, are necessary to this end.

Improve the transparency and regulation of financial markets through measures to capture more data on index fund activity and to examine cross-exchange interactions in the crude market.

Enhance the quality, completeness and timeliness of oil data submitted through the monthly Joint Oil Data Initiative (JODI), covering production, consumption, exports, imports and stocks. In order to further improve market transparency and stability, the seven organisations involved in JODI (APEC, Eurostat, IEA, IEF, OLADE, OPEC and UNSD) could start work to cover annual data, which includes, among other things, upstream and downstream capacities and expansion plans.

Immediate collaboration between the IEA and OPEC Secretariats, together with the IEF Secretariat, on preparing shared analyses of oil market trends and outlook, as well as of the impact of financial markets on the level and volatility of oil prices, which can be used to better understand the market situation.

Intensify development assistance from the national, regional and international finance and aid institutions, to alleviate the consequences of higher oil prices on the least-developed countries.

Enhance cooperation among international, national and service companies from all producing and consuming countries in investment, technology and human resource development.

Promote energy efficiency in all sectors, through passing on market price signals, technology transfer and the sharing of best practices in energy production and consumption.