Times
, 17 May 2004) and ‘world braced for oil shock’ (
Observer
, 11 May 2004). Prices continued remorselessly upwards ever since until the crash at the end of 2008.
The simple and obvious explanation for this prolonged rise is that the world economy has been growing very strongly in this
century, faster than ever previously recorded. Specifically, there has been remarkably rapid growth in China, with 8–10 per
cent annual expansion (Chinese numbers are not totally reliable, but few dispute this broad order of magnitude and the visible
transformation of the country that has resulted from it). India is growing rapidly from a lower base. This expansion has fed
into energy demand as industrialization has advanced and living standards have risen. Quite understandably, Chinese and Indian
families wish to turn their increased income into the higher quality of life most of us take for granted: greater mobility,
derivingfrom the ownership of vehicles; improved public transport and aviation; and comfortable levels of domestic heating, for example.
China currently has around 40 million motor vehicles, less than the USA in 1949 and less than one fifth of the current US
level (which stands at 250 million). India’s launch of a family car costing less than $2000 speaks to a similar ambition in
that country. In the first seven years of this century China and India accounted for 50 per cent of the increase in the world’s
primary energy demand (approximately 45 per cent from China alone), and 35 per cent of the increase in oil demand. With the
slowing down of the main Western economies in the last two years, a substantial majority of the incremental demand for oil
is coming from these countries, especially China. In the years from 2005 to 2007 inclusive, world demand grew by approximately
1.5 million barrels / day on average, and of that 1.3 million barrels / day came from non-OECD countries, led by China.
World oil supply, while growing, did not keep pace. We shall explore later whether this was the consequence of a fundamental
long-term problem or of a series of conjunctural factors: under investment following a period of low prices; the Iraq War,
following a decade of sanctions, which left production at around 2.5 million barrels / day, less than half the estimated potential;
violence in oil-producing regions of Nigeria, causing substantial under production; US sanctions which have inhibited Iranian
production, and Iran’s own willingness to cut production to make a political point; disruption of production in Venezuela;
and production falls in Russia. Much as in the early 1970s, steadily expanding demand, outstripping supply, ate away at spare
capacity (much of which is in Saudi Arabia). From over 5 per cent of production in 2002 spare capacity fell to 2.5 per cent
in 2004, and then to just over 1 per cent (1 million barrels / day). Saudi Arabia has expressed an intention to increase production
capacity through a large investment programme, though this will be slow to come through. Any system operating on such wafer-thin
cap acity margins was dangerously poised for an extreme pricereaction, which is what we have seen, just as we did in 1973. Yet the spike of prices in 2008 has passed. Prices crashed to
$40 per barrel as increased production met falling demand due to the global recession. This was a world far removed from the
prediction of a $200 ‘super-spike’, as Goldman Sachs analyst Arjun Murti proposed recently, which was reflected in the option
contracts on oil at $200 per barrel. But this is a market that never stands still for long. By September 2009, crude prices
had revived to $70 per barrel following production cutbacks and news of tentative economic recovery.
This volatility prompts a series of questions. First, how much of the recent ‘spike’ can be attributed to ‘speculation’ rather
than underlying supply and demand factors? Second, while an oil
, 17 May 2004) and ‘world braced for oil shock’ (
Observer
, 11 May 2004). Prices continued remorselessly upwards ever since until the crash at the end of 2008.
The simple and obvious explanation for this prolonged rise is that the world economy has been growing very strongly in this
century, faster than ever previously recorded. Specifically, there has been remarkably rapid growth in China, with 8–10 per
cent annual expansion (Chinese numbers are not totally reliable, but few dispute this broad order of magnitude and the visible
transformation of the country that has resulted from it). India is growing rapidly from a lower base. This expansion has fed
into energy demand as industrialization has advanced and living standards have risen. Quite understandably, Chinese and Indian
families wish to turn their increased income into the higher quality of life most of us take for granted: greater mobility,
derivingfrom the ownership of vehicles; improved public transport and aviation; and comfortable levels of domestic heating, for example.
China currently has around 40 million motor vehicles, less than the USA in 1949 and less than one fifth of the current US
level (which stands at 250 million). India’s launch of a family car costing less than $2000 speaks to a similar ambition in
that country. In the first seven years of this century China and India accounted for 50 per cent of the increase in the world’s
primary energy demand (approximately 45 per cent from China alone), and 35 per cent of the increase in oil demand. With the
slowing down of the main Western economies in the last two years, a substantial majority of the incremental demand for oil
is coming from these countries, especially China. In the years from 2005 to 2007 inclusive, world demand grew by approximately
1.5 million barrels / day on average, and of that 1.3 million barrels / day came from non-OECD countries, led by China.
World oil supply, while growing, did not keep pace. We shall explore later whether this was the consequence of a fundamental
long-term problem or of a series of conjunctural factors: under investment following a period of low prices; the Iraq War,
following a decade of sanctions, which left production at around 2.5 million barrels / day, less than half the estimated potential;
violence in oil-producing regions of Nigeria, causing substantial under production; US sanctions which have inhibited Iranian
production, and Iran’s own willingness to cut production to make a political point; disruption of production in Venezuela;
and production falls in Russia. Much as in the early 1970s, steadily expanding demand, outstripping supply, ate away at spare
capacity (much of which is in Saudi Arabia). From over 5 per cent of production in 2002 spare capacity fell to 2.5 per cent
in 2004, and then to just over 1 per cent (1 million barrels / day). Saudi Arabia has expressed an intention to increase production
capacity through a large investment programme, though this will be slow to come through. Any system operating on such wafer-thin
cap acity margins was dangerously poised for an extreme pricereaction, which is what we have seen, just as we did in 1973. Yet the spike of prices in 2008 has passed. Prices crashed to
$40 per barrel as increased production met falling demand due to the global recession. This was a world far removed from the
prediction of a $200 ‘super-spike’, as Goldman Sachs analyst Arjun Murti proposed recently, which was reflected in the option
contracts on oil at $200 per barrel. But this is a market that never stands still for long. By September 2009, crude prices
had revived to $70 per barrel following production cutbacks and news of tentative economic recovery.
This volatility prompts a series of questions. First, how much of the recent ‘spike’ can be attributed to ‘speculation’ rather
than underlying supply and demand factors? Second, while an oil
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