may seem hard to believe now, but for more than half
a century, world oil prices have not moved much around
the average figure of US $27 per barrel in 2007 price
terms. The occasional shifts away from this average
have been few and the periods of oil price spikes
were relatively short, with the most notable being
the OPEC-induced "shocks" of 1970s. Between
the mid-1980s and 2003, the real price (that is adjusted
to inflation) of crude oil on the major international
trading exchanges was typically less than $25 per
The recent rise in the price of oil began in 2004,
when it became evident that the US invasion of Iraq
was going to be ineffective in securing Iraq’s oil
reserves for the US. However, even then the price
rise was substantial without being a surge. It is
really only in the past year that the global oil price
has behaved like a runaway horse, breaking all speed
limits and previous barriers. In the three years between
January 2004 and April 2007, the oil price in nominal
dollar terms increased by around 2.3 times, to $65
a barrel. But in the period between then and early
June this year, that is just 14 months, the price
more than doubled again, to reach a peak of $139 per
barrel on 6 June before coming down very slightly
to $132 on 10 June.
A price of around $100 per barrel in 2007 prices would
be equal to the maximum achieved in the post-World
War II period, in 1980. So the global price of oil
is now higher in real terms than it has been since
the 1920s. And the rate of increase of oil prices
in the past year has been the fastest ever recorded.
Also, there seems to be no ceiling in sight: some
market analysts have gone on record to predict oil
prices of $150-200 per barrel by the end of the year.
This has already spawned a mini-industry of explanations
as to why this has happened. And, just as in the case
of global food prices, the various explanations reflect
not so much the clear empirical evidence so much as
the interests of those presenting them. Thus, it is
common for policy makers and commentators in the developed
world to argue that the current high oil prices are
essentially the fault of the developing world: a combination
of supply cutbacks by OPEC and increased demand from
the rapidly growing economies of China and India.
However, both of these factors, while they may at
some point in future play a role in changing the long-term
conditions of the world oil market, have next to nothing
to do with the most recent increase in oil prices
over the past year. But to understand this, it is
necessary to consider each of the most commonly advanced
arguments in turn.
Most of the explanations deal with supply conditions.
One argument that has been around for a while is that
of "peak oil" – the position that global
oil reserves are running out, and may have already
peaked or will shortly peak. The most extreme proponents
of this position also believe that more investment
in exploration will do little to change this imbalance,
and therefore the world must learn to shift to alternative
forms of energy, whether fossil based or renewable.
In this perception, the current spike in price is
simply the inevitable effect of more than a decade
of denial, which is making the inevitable adjustment
that much sharper and more painful.
However, for this to be true, it should be reflected
in growing imbalances between actual consumption of
oil and global supplies. But this is not the case,
as will be evident below.
Then there are those who note the more proximate effects
on supply of particular political and economic trends.
The continuing instability in Iraq continues to affect
its production and exports of oil. Recent terrorist
attacks in Nigeria have reduced drilling and production
in that country. Production is falling in Venezuela
because of aging oil fields. Tensions in the Middle
East, whether because of fears of an Israeli attack
on Iran or continuing conflicts in Palestine, are
also said to have an impact on oil supplies and therefore
A slightly different argument posits that the falling
value of the US dollar affects oil supplies, because
the oil trade is generally denominated in dollars.
This makes producers prefer to keep the oil in the
ground rather than extract it to be paid in depreciating
dollars. However, this argument is flimsy, not only
because it is not essential to denominate the trade
in dollars, but because there is no real evidence
that the fall in the US dollar is linked to suppliers'
behaviour. Indeed, it may be more likely that the
causation may be the other way around – that rising
oil prices cause dollar depreciation by pushing up
the US import bill.
The more ridiculous of the supply-side arguments is
the one that blames OPEC for the current situation.
This view is more common than might be expected: Prime
Minister Gordon Brown of U.K. has railed against the
"scandal" of the continuing market power
of OPEC and the US Congress is actually trying to
bring a lawsuit against OPEC for cartel-like behaviour
and price manipulation! This remarkably stupid move
ignores that fact that since the 1980s, OPEC has not
fulfilled the basic requirement of a cartel: a mechanism
to enforce quotas upon its members.
In fact, today OPEC is more like a club of some oil
producers, rather than a cartel that is in command
of world oil supply. It controls only about 40 per
cent of world oil production, compared to 70 per cent
in the early 1970s. And it has been remarkably inefficient
in imposing any kind of production quota on its members,
who have happily increased or decreased their production
as they wished. Most of its members are producing
exactly as they would if OPEC did not exist. And in
any case, OPEC has been around for more nearly five
decades, and for most of that period the world oil
price has been around $27 a barrel.
The argument appears even more foolish once it is
known that the slight decline in global oil supply
in April 2008 (compared to a year ago) is entirely
because of non-OPEC oil exporters, since the supply
from OPEC countries was actually higher by 1.7 million
barrels per day. In any case, the Oil Minister of
the largest OPEC producer, and indeed the world largest
oil producer, Saudi Arabia, has already announced
that “any demand for extra production capacity from
consumers will be immediately met", so it is
somewhat bizarre to blame the current high prices
The other argument popular in the North relates to
demand, and suggests that the voracious demand for
oil in China and India – which in turn is fed by heavy
state subsidies that keep the domestic prices of fuels
down – is responsible for the recent price surge.
This argument appears to be superficially plausible,
but once again it is fallacious. It is true that China’s
demand for oil, in particular, has been increasing
rapidly, but it still accounts for less than 8 per
cent of global consumption, and India for less than
3 per cent.
The current obsession with subsidies ignores the taxes
imposed on petroleum prices that affect retail domestic
prices. In fact, despite recent increases, the US
still has among the lowest domestic prices of fuel
in the world, substantially lower than India even
in nominal terms. Relative to per capita GDP or actual
purchasing power, the domestic retail prices of oil
and oil products in India and China are many multiples
of the prices prevailing in the US. So the subsidies
leading to excessive fuel consumption are much more
prevalent in the US than they are in India or China.
In 2007, import demand from China and India together
increased by 8.7 per cent, but import demand from
the other five large importers (US, Japan, Germany,
France, Italy) actually fell by 2.6 per cent. As a
result, demand for oil from the top ten importing
countries actually declined by 0.5 per cent. Even
so, the global oil price increased by 170 per cent!
The scenario appears to be similar in the current
year. According to projections of the Energy Information
Administration of the US Government, OECD oil demand
will contract for the third successive year in 2008.
While non-OECD demand growth in 2008, led by China
and the Middle East, will remain reasonably strong
at 3.7 per cent, aggregate global demand will increase
by only 1.2 per cent. Supply is expected to be approximately
the same as the previous year, at around 86 million
barrels per day. Yet in the first five months of this
year, global oil prices have increased by more than
140 per cent.
From all this it is quite evident that the straightforward
explanations based on real demand and supply are simply
not useful in understanding the current price hike.
Rather, the price for this very physical commodity,
this universal intermediate, is now determined in
the virtual world. In other words, speculative forces,
operating especially through the commodity futures
markets, are driving the current oil price surge.
Just as in the case of other primary commodities,
financial deregulation has played a role in allowing
this to happen. Two major international exchanges
are crucial to this process. The New York Mercantile
Exchange (NYMEX) and the Intercontinental Exchange
(ICE) in London control futures contracts on two of
the most widely traded grades of oil: West Texas Intermediate
and North Sea Brent. This becomes a benchmark for
spot prices of actually traded cargo. For the past
few years, the oil market has been operating in what
is known as "contango", meaning that futures
contracts for oil are priced higher than oil directed
to spot delivery. As futures prices keep rising, they
push up spot prices as well, regardless of the ground
situation with respect to actual consumption and actual
The problem is that the futures market is largely
unregulated, because of the growth of OTC (Over the
Counter) electronic markets that were allowed in the
early years of the decade in the US, and because the
ICE in London is also not subject to regulation. As
a result, this has led to “a process so opaque only
a handful of major oil trading banks such as Goldman
Sachs or Morgan Stanley have any idea who is buying
and who selling oil futures or derivative contracts
that set physical oil prices in this strange new world
of "paper oil."
(F. William Engdahl, http://www.globalresearch.ca/index.php?context=va&aid=8878)
The problems with such unregulated markets have been
evident for some time now. In June 2006, a US Senate
Permanent Subcommittee on Investigations published
a report on "The Role of Market Speculation in
Rising Oil and Gas Prices" (the Levin-Coleman
Report). This was largely ignored by the media and
indeed by US policy makers, but its findings have
great relevance today. Some of its conclusions are
worth quoting in detail: "There is substantial
evidence supporting the conclusion that the large
amount of speculation in the current market has significantly
increased prices (because of) a tremendous growth
in the trading of contracts that look and are structured
just like futures contracts, but which are traded
on unregulated OTC electronic markets". As a
result, the Report noted that there has been a significant
reduction in the possibilities of market oversight.
"With respect to crude oil, the influx of speculative
dollars appears to have altered the historical relationship
between price and inventory, leading the current oil
market to be characterized by both large inventories
and high prices."
Because it is so unregulated, it is not even possible
to figure out who the major players (and therefore
major beneficiaries of the oil price rise) are, but
it is clear that oil producers are not benefiting
much even as oil consumers suffer. It may well be
that, in addition to financial institutions that have
specialised in commodity futures trading, large transnational
banks that have burnt their fingers in the US housing
market and desperately need to recoup their losses
are entering this market and driving up prices to
make quick speculative gains.
There is some evidence of the involvement of large
players in this market. Goldman Sachs and Morgan Stanley
are the two leading energy trading firms in the United
States. Citigroup and JP Morgan Chase are major players
and fund numerous hedge funds as well who speculate.
In the past five years investment in index funds tied
to commodities has grown from $13 billion to $260
billion. Hedge funds, investment banks, pension funds,
and other professional investors increasingly direct
their financial resources into oil and other commodities.
This is supposed to create a hedge against inflation,
but of course it ends up contributing to it.
Such speculation has become the most profitable form
of financial activity as well. According to HSBC,
commodity and energy weighted funds topped the list
of "best performers" in the financial markets
in the past three months, generating on average more
than 30 per cent annual returns even as other hedge
funds suffer losses.
There has been some belated and minimalist policy
action against this tendency. On May 30, responding
to much criticism, both NYMEX and ICE London tripled
"margin calls" for their contracts, forcing
traders to deposit more money when investing. It is
after that that the price per barrel of Brent Crude
oil fell from $139 to $132, suggesting that it may
have had a minor impact in curbing extremely speculative
So, just as for major food grains, deregulation of
financial markets has had a significant role in affecting
global oil prices. Therefore, it is likely that the
current oil price spike reflects a speculative bubble.
If so, like all bubbles, it will eventually come to
an end. Of course, this bursting of the bubble may
take longer than could be expected – remember that
the US housing bubble carried on for several years
– but even so it is essentially transient. This means
that policies in developing countries must also factor
in this possibility, especially before trying to pass
on the adverse effects of the oil price hike on to
the working people.