IDEAS21

These days the news is full of dire warnings about another financial meltdown emanating from the sovereign debt crisis in Europe. Professor Nouriel Roubini, who was catapulted to international fame after correctly predicting the 2008 financial crash, says Europe is sliding into a ‘double-dip’ recession – if not depression – and a break-up of the eurozone is increasingly likely.

So in the face of this downside economic risk, why does the price of oil remain stuck above $100 per barrel? What are the short, medium and long-term prospects for oil prices? And most importantly, what do the underlying currents imply for future economic prosperity?

To answer these questions, we need to interrogate the ‘usual suspects’: the insatiable Chinese dragon; supply fundamentals; the OPEC (Organisation of Petroleum Exporting Countries) cartel; the geopolitical risk factor; and assorted speculators.

Before starting the inquisition, some historical context is useful. Between 1986 and 2003 the oil price traded in a remarkably stable and narrow range, averaging about $20 per barrel. From 2003, it rose steadily for several years and then spiked dramatically to reach an all-time nominal peak of $147/barrel in July 2008. When the world sank into recession after the global financial crisis later that year, demand for oil fell rapidly and the oil price plunged to around $40/barrel. Since then, the price has ratcheted up again, and has traded in triple figures for the whole of 2011.

The resilience of the oil price reflects first and foremost the tightness between the global supply and demand for oil.

Despite oil consumption having apparently peaked a few years ago in the industrialised countries, demand for oil products continues to grow apace in emerging economies.

China leads the pack, expanding its oil consumption by nearly 10% a year. Last year 13 million new cars were sold in China, topping US vehicle sales for the first time ever. And it seems that whenever the oil price falls, China taps into its vast foreign exchange reserves – over $3 trillion and counting – to stockpile crude for its strategic petroleum reserve.

Meanwhile, oil producers can’t seem to meet demand like they used to. A number of independent oil analysts have been warning for years that oil production could reach its all-time peak early in the 21^st century. Now even the International Energy Agency agrees that conventional crude oil output likely peaked in 2006. The data show that world liquid fuel production has been essentially stagnant for the past six years, aside from an increase in biofuel output that has in turn boosted food prices.

Global spare oil capacity is now minimal, which means that the slightest market disturbance can trigger big price fluctuations.

Furthermore, most new oil sources outside a few Persian Gulf states – many of which are in deep water – have marginal production costs of around $80 per barrel. Canada’s tar sands have marginal costs of about $90-100.

Another perennial suspect is OPEC countries: most of them can no longer ‘afford’ for the price to drop below $100, as they are dependent on high oil revenues to maintain government spending and social stability.

Speculators no doubt played a part in amplifying the wild price gyrations in 2007-2009, but without fundamental price drivers they would have nothing to bet on.

Our final suspect is geopolitical risk. Certainly, the conflict in Libya this year played a significant role by taking about 1.2 million barrels per day of world oil exports offline. And tensions persist throughout the Middle East region, centred now on Syria and Iran.

So all in all, there are many forces keeping the oil price in three digits. Meanwhile, there seems to be a ceiling for oil prices at around $120; above this level, it destroys demand.

Forecasting oil prices with any great precision is notoriously difficult. Nonetheless, we can be reasonably confident about certain trends.

In next year or two the oil price kite will continue to be buffeted by the winds of financial turmoil and an increasingly tight demand/supply balance. If the world economy continues to grow, spare oil capacity will essentially disappear next year. But if Europe falls into a financial/economic abyss, the oil price could drop markedly, although probably not for very long.

For the remainder of this decade, the greatest likelihood is that oil prices will continue their volatile swings, but around a rising trend driven by falling supply.

Beyond that, the trajectory for oil prices will depend largely on how governments and societies respond to diminishing oil supplies. If they attempt to continue business-as-usual and compete for a shrinking pool of the black liquid, it will become increasingly unaffordable and engender economic chaos.

If, on the other hand, there is a concerted mobilisation to reduce oil dependency through conservation and efficiency, investing in alternative energy supplies, and electrifying transport systems, then eventually the oil price train could run out of steam.

Indeed, the economic fortunes of the world hinge on which of these scenarios comes to pass. The window of opportunity for launching a crash programme to mitigate the impending decline in oil production and accelerate a transition to a sustainable global economy is rapidly closing.

So fasten your seatbelt and tighten your economic belt: 2012 promises to be another wild ride on the oil roller-coaster.

Published in the Mail & Guardian, 25 November 2011.

After a hectic Rugby World Cup Final and a pool tournament (which I lost by one point in sympathy with the Tricoleurs), I retired to bed soon after 8pm. Just before dropping off, I was rudely shaken from my impending slumber by the frantic, ear-splitting barking of my daughter Jade’s Daschund puppy. My wife rushed out onto the stoep, expecting to find one of the chickens in death throws at the hands (I mean, paws) of some or other nocturnal predator – genets and mongooses being the most common culprits. However this time we could hear a deafening fight for survival going on across the stream on our neighbour’s property – it sounded something between a Jack Russell and a young baboon screaming in agony.

Throwing caution to the wind (well, actually it was a perfectly still evening), I donned my wellington boots, grabbed my spotlight torch and bravely headed off to investigate what foul murder was taking place. I jogged up the path through our little grove and slipped through the gate onto our neighbour’s access road, following it down a short hill to where it crosses the stream. There I stopped and pulled the trigger on my torch, and a one million candle power beam illuminated the violent scene some 25 metres up the track.

To my great surprise, I witnessed a tug-o-war between two Honey Badgers, the ‘rope’ being a third Badger. I watched in fascination as these black-and-silver, solid but squat little beasts fought in a ferocious tumble of teeth and claws. They stand about 30cm high and are up to a metre in length from nose to tail tip. After an eternity of seconds, they suddenly stopped fighting and screeching, and looked towards me. At least one immediately started running towards me, fearless (it seemed fearless too).

Instantly deciding that ‘discretion was the better part of valour’ (apologies to Chick Henderson, the venerable SA rugby commentator), I turned tail and sprinted back up the hill. Now in case you think I was unduly cautious, don’t let the sweet-sounding name “honey badger” mistake you. The Afrikaans name for this rugged creature is the “Ratel”, a name adopted for the South African-made armoured troop vehicle celebrated for its ability to withstand landmine explosions. And if you’ve watched the classic Jamie Uys film “The Gods Must Be Crazy II” (which coincidently – or not – I watched for the first time just a week ago), you’ll know that once a Ratel bites your boot, it never lets go.

When I reached the top of the rise after about 40 metres I stopped momentarily and shone my torch back down the track – only to see two bright blue lights growing larger every split second. No, it wasn’t the police; it was the Ratel’s eyes reflecting the torch light. So on I sprinted for another 40 yards or so till I reached the wrought-iron entrance gate, where I paused again to see if my stalker had given up the chase. But no, it was still in hot pursuit! Over-wrought was not an option, so I squeezed between the bars of the gate and hurtled down the road, jumped over a barb-wire fence and raced around to our cottage, shouting to Jacqui to get our two diminutive dogs inside.

Whew, that was close! Panting like a dog, I retrieved my Field Guide to Mammals from the bookshelf and flipped to the Honey Badger entry. There the section on behaviour confirmed the prudence of my quick-witted reactions: “Very territorial and aggressive. Have been known to attack elephant and buffalo, and humans when threatened.”

In any event, I felt quite chuffed as I’d managed to break up the fight – clearly at least one Ratel had engaged the classic psychological defence mechanism of ‘transference’, and decided to vent its aggression on me instead of its rivals. The rest of the night, all was peaceful and quiet on the little Riverndale Farm we know so well.

In case you think I’m over-dramatising, check this out:

http://www.badassoftheweek.com/honeybadger.html