The year 2012 became the second in a row to start with a run-up in oil prices. In 2011, the price of benchmark West Texas crude began to climb early and topped out at nearly $120 per barrel at the end of April. Oil inaugurated this year by climbing above $100 and reaching its highest level in eight months.
In general, oil prices have been quick on the upside. Following the global financial crisis, oil dipped only briefly and staged a prompt recovery, even though global economic growth remains sluggish. This has revived concerns that the world is running out of oil, which have been dormant since the 1980s.
Indeed, over the past decade there has been a major increase in demand for oil. China in particular has been blamed for straining world supplies and driving up oil prices thanks to its extremely rapid pace of economic growth. China has slowed down recently, but its GDP still grew by a formidable 8.9 percent in the fourth quarter of 2011, with robust growth now coming from a much higher base.
Other large developing countries are also industrializing fast, and using more oil. Plus, China is now the world’s largest market for motor vehicles, with 14.5 million cars sold last year, or 2 million more than in the United States. In India, car sales are expected to reach 5 million in five years. Brazil, Indonesia, Turkey and Russia also have a large, and expanding, army of motorists. Collectively, these countries have more than 3 billion inhabitants, so their love for their set of wheels may spell trouble for global oil supplies.
Some analysts are predicting an era of very expensive oil, a global race to secure oil sources and even armed conflicts over oil.
Oil prices, however, are never a one-way bet. If past history teaches us anything about the oil market, it is that whenever analysts start predicting a sea of cheap oil (as they did in the early 1970s and again in the mid-1990s), it is time to prepare for a price hike. Similarly, when we start hearing about oil shortages (as we did throughout the 1970s and the early 1980s), it is a surefire sign that oil prices are on their way down.
Traders on the NYMEX derivatives market apparently have learned this lesson. They have been anticipating wide swings in oil prices. The second half of 2011 was marked by a sharp increase in new out-of-the-money option contracts, which would become profitable if oil rose into the $130-155 range or fell in the $45-60 range by end-2012. During the second half, the number of such contracts jumped by around 30 percent.
A plausible case may be made for a coming oversupply of oil, especially since current prices in the $80-100 range make many exploration and production projects economically viable. Even amid political controversy over the Keystone XL pipeline, new technology allows commercial extraction of oil from Canadian shale sands, making Canada a world leader in terms of oil reserves. New offshore discoveries have been made off the coast of Brazil, in the South China Sea and on the Arctic Shelf, while new technologies make deep sea drilling possible.
Natural gas, meanwhile, which can replace oil in energy production, traded in mid-January at its lowest price since 2002, thanks to the hydro fracking technique used to extract gas from rock formations in New York and Pennsylvania, among other places. There have been new discoveries, as well, for instance off the Mediterranean coast of Israel.
The problem with oil is not so much a shortage of supply as political instability among oil exporters. Last year’s run-up in oil prices was the result of the Arab Spring, a series of protests and revolutions which spread through the Arab Middle East and North Africa. This year, oil is on the move because of rising tensions with Iran and the threat by Tehran to shut down the Strait of Hormuz.
The Strait of Hormuz is the Achilles’ heel of the global oil market. The 30-mile-wide body of water is traversed by oil tankers carrying one fifth of the world’s oil supply, or some 17 million barrels of crude daily.