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Even though European austerity-related taxes on gasoline and diesel are pushing down demand, the price at the pumps is steady or rising. (JO YONG-HAK/JO YONG-HAK/REUTERS)
Even though European austerity-related taxes on gasoline and diesel are pushing down demand, the price at the pumps is steady or rising. (JO YONG-HAK/JO YONG-HAK/REUTERS)

All the signs point to a falling oil price - except supply Add to ...

If you want a recipe for falling global oil prices, you would think this would do the trick.

The 17-country euro zone, which includes three Group of Seven countries, is back in recession. The shale deposits in the United States are gushing oil. Libyan supplies are coming back with a vengeance. Iran has not been bombed and, if the blathering Beltway pundits are right, will not be bombed before the U.S. election. The Strait of Hormuz is wide open. The latest generation of cars makes the fuel economy of your dad’s old banger look like the Exxon Valdez’s. European austerity-related taxes on gasoline and diesel are pushing down demand.

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Why, then, are oil prices so high, to the point they threaten the tentative economic recoveries in debt-bombed Europe and elsewhere?

This week, oil prices went to their highest level since mid-2008, just before the collapse of Lehman Bros. triggered the same response in oil prices. Propelled partly by dubious rumours of a pipeline explosion in Saudi Arabia, Brent crude (the better global proxy than West Texas intermediate ) went above $128 (U.S.) a barrel on Thursday. On Friday, oil was at $124.

In the first two months of 2012 alone, prices have climbed by almost a third, after a 21-per-cent rise last year. In early 2009, when investors seemed convinced that only planetary annexation by cash-rich Martians with MBAs would save us, the price went as low as $34 from a pre-crisis peak of $147.

In spite of the sharp price increase, there is no shortage of economists and analysts who think that sinking prices are more likely than the opposite. Their theory is that the euro zone debt crisis, which has already put three countries on life support and could end with the eradication of the common currency, still has ample potential to take down the global economy. Sorry United States and China, Europe is still the world’s biggest economy and if it fails, the repercussions would be ugly.

What they forget, or at least play down, is that global demand is rising in spite of sluggish demand in tapped-out Europe. But that’s not really the point; the point is that it’s rising when oil producers themselves seem close to tapped out. Spare production capacity is razor thin. Production in the non-OPEC countries has been hugely disappointing. The American shale deposits are overhyped. And we haven’t even talked about potential supply disruptions in Iran and Iraq.

Given the tight balance between supply and demand, any disruption could send the price soaring. The capable oil analysts at Barclays Capital in London have put their Brent forecast at $115 a barrel this year. But they think quarterly averages as high as $150 “are distinctly possible” even if the Persian Gulf doesn’t turn into a pool of blood and oil.

Oil has been climbing pretty much steadily since early 2009, one of the strongest sustained rallies on record, in good part driven by relentless demand in Asia and the former Soviet Union states. When the commodity price chart takes off at a 45-degree angle for that long, you normally get a compelling supply response – more of the commodity is produced. In the oil markets, that response has not come, at least globally speaking. To be sure, it has in the United States, where surging shale oil production, combined with rising imports from Canada, home of the Alberta oil sands, have pushed down offshore imports as a share of consumption to about 45 per cent from a high of 60 per cent in 2005.

Why hasn’t the high price triggered a production surge? The biggie, it seems, is that the non-OPEC countries are simply not up to the job. As Barclays points out, non-OPEC supply last year landed at a full one million barrels a day less than forecast by the International Energy Agency. The North Sea (whose production is shared by Britain and Norway) continued its terminal decline. Brazil and Azerbaijan were also the scenes of production disappointments.

Meanwhile, OPEC, dominated by Saudi Arabia, is sweating exceedingly hard. OPEC production volumes are at three-year highs, to the point that the cartel has only about 1.6 million barrels a day of spare capacity, and still prices are climbing.

All of which raises the question: What happens when demand really takes off?

It could, easily. Note that the U.S. economy is on the mend. And Europe? In spite of the euro zone recession, business and consumer sentiment indicators are bottoming out, or rising. Germany, the engine of European growth, is a juggernaut and Greece has been bailed out for a second time, removing the immediate threat of default and exodus from the euro.

Japan, meanwhile, is importing vast amounts of oil to replace crippled nuclear generating capacity, putting upward pressure on prices.

In the United States, shale oil is welcome, but it will never eliminate the country’s reliance on imports or make it a net oil exporter.

One final point. While we can debate until our gums bleed whether the world has reached, or is close to reaching, peak oil, we can say with some confidence that triple-digit prices are here to stay. Note that Saudi Oil Minister Ali al-Naimi recently said his goal is to stabilize prices at “around $100.”

Sounds like a price floor, doesn’t it?

Follow on Twitter: @ereguly

 
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