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All the signs say oil’s rise has ended – except the most important, demand Add to ...

Crude oil prices have recovered much of the ground they lost during the financial crisis and global recession, but can investors hope for more gains ahead?



The rebound has certainly been impressive. Oil – specifically, the benchmark West Texas intermediate – has surged 160 per cent from its low in 2009, and recently hit its highest level in 2½ years. Already, observers have begun to fret about the usual impact of high energy costs, including their potential to drive up inflation and drive down economic growth.



If these fears were enough to halt oil’s rise, then this would probably be a good time to familiarize yourself with the exits. But let’s face it, they aren’t: Oil, and other commodities for that matter, can blast through warning signs and psychological barriers – and it seems likely that oil’s current upward journey has further to go.



The economic backdrop remains uncertain, which is most likely built into the current oil price and leaves plenty of upside ahead. China, which recently overtook the United States as the world’s largest energy consumer, has been showing signs of slowing down. In January, its purchasing managers’ index, which reflects manufacturing activity, slumped more than expected.



Europe remains troubled, due in part to massive deficits and incoming austerity measures, which are likely to sap economic growth. The United States, while showing signs of improving, still has nearly 13.9 million people looking for jobs – and job seekers tend not to buy cars.



Despite these economic concerns, oil demand nonetheless has been going up, up, up. When the price of oil hit its record high in 2007, oil demand was 86.5 million barrels a day, according to the International Energy Agency. After falling during the recession, oil demand in 2010 blew past that amount, hitting 87.7 million b/d. And the IEA forecasts that demand will rise again in 2011, hitting 89.1 million b/d.



In other words, the current price of oil is 38 per cent below its 2007 peak, yet oil demand is considerably higher than it was back then. Even if the price of oil in 2007 was a little frothy, due to speculative fervour at the time, rising demand implies that the price of oil could rise substantially from its current level when the global economy truly starts humming again.



Of course, there are a lot of moving parts here. In particular, oil prices can move with statements from the Organization of Petroleum Exporting Countries – and Saudi Arabia’s Energy Minister recently hinted that OPEC could open its taps if rising oil prices threaten economic growth.



But against rising global energy demand, OPEC’s role in determining the price of oil looks fairly weak, at least in the longer term. If the current price of oil hasn’t hurt the global economy, it’s a good bet that the economy can absorb even higher prices ahead.

 

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