Just as the U.S. economy seemed to be finding its feet again, along comes an oil-price spike to throw a wrench into things. Crude prices in New York and London hit 13-year highs on Tuesday, driven in part by strong demand from Asia, but also by fear that terrorism could hurt oil flows from Saudi Arabia, the world's largest producer and the linchpin of the OPEC oil cartel. Even if those short-term concerns subside, some analysts believe that $40 oil will soon become a reality, and one that could be here to stay — and that has serious implications for both the U.S. and for Canada.
Just as the U.S. economy seemed to be finding its feet again, along comes an oil-price spike to throw a wrench into things. Crude prices in New York and London closed at 13-year highs on Wednesday — driven in part by strong demand from Asia, but also by fear that terrorism could hurt oil flows from Saudi Arabia, the linchpin of the OPEC oil cartel. Even if these shorter-term concerns subside, some analysts believe that $40 (U.S.) oil will soon become a reality, and one that could be here to stay — and that has serious implications for the U.S. and Canada.
Global oil prices — both for the light West Texas intermediate that is the standard in North America and for the heavier Brent variety that is the European standard — have climbed more than 20 per cent so far this year, and are up by almost 50 per cent compared with last year at this time. The peaks that both oil contracts hit on Wednesday ($36.72 U.S. per barrel on the London petroleum exchange and $39.57 on the Nymex exchange) were the highest since just before the Gulf war in 1990.
Part of the impetus for the price rise has been — not surprisingly — the actions of OPEC, which decided in April to cut its official production quotas (which are lower than the group's actual production levels, due to widespread cheating). Although prices were above the group's "band" of $22 to $24 a barrel in April, the cartel was concerned that the drop in demand that commonly occurs in the second quarter of the year (as demand for heating oil falls), might leave inventories high and put downward pressure on prices.
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Instead, the opposite has happened. Demand has remained strong from both the U.S. and from emerging markets such as China and India, where economies are growing at a fairly rapid pace. Meanwhile, there has been less oil flowing from Iraq due to disruptions caused by the war, and there have been periodic flare-ups in other areas that have kept oil traders nervous. The latest was the killing of five Western workers at a chemical plant in Saudi Arabia, which helped push crude prices to recent highs — in part because of the fear that future attacks could hit the oil industry.
Saudi Arabia is not only the largest producer in OPEC, it is also the only cartel member with spare production capacity — and is therefore the only one that can turn on the taps if necessary to try and take some of the froth out of the market. Although other non-OPEC producers such as Russia have been increasing production, any serious interruption in Saudi supply would still have a severe impact on the market. The threat of terrorism may still be just that, but there is no doubt that the ruling al-Saud family has come under increasing pressure from radical elements within Saudi Arabia for its friendly ties with the United States, and that has increased the risk of attacks.
OPEC and even some independent analysts say a portion of the upward move in crude prices has come from oil traders trying to capitalize on these fears. There are those who believe, however, that even beneath these short-term factors the supply-demand balance in the global oil market is very tight, which means continued upward pressure on prices. For example, a senior OPEC source recently told Dow Jones that the cartel never followed through on its promised cuts in April, but continued to produce at earlier levels to try and ease prices. Despite this, crude has continued to climb.
In addition to growing demand from China and India, analysts say the rate of decline in existing oil fields in Saudi Arabia and elsewhere is proving to be higher than many producers expected, and that has reduced long-term supplies. The problem for the U.S. is that higher oil prices — which in turn have produced record gasoline prices — couldn't have come at a worse time. The economy is beginning to strengthen, but higher crude and gas prices could hit the consumer, and also lead to higher inflation, which in turn would put more pressure on the Federal Reserve to raise interest rates. That could crimp growth just when it is most needed.
The International Energy Agency said Monday that high oil prices could "inflict substantial damage on the economies of oil-importing countries and on the global economy." Canada, meanwhile, benefits from higher oil prices in the larger sense — despite the hit for consumers at the gas pump — but the higher Canadian dollar has removed much of the benefit from higher prices, as the recent quarterly results from Encana and other major oil producers indicate. And if higher oil prices and/or higher interest rates slow growth in the U.S., Canada could suffer as well.
Marshall Auerback, a portfolio strategist with U.S. money manager David Tice & Associates, says the risks surrounding a higher oil price imply "an increasingly precarious backdrop for U.S. financial assets and the dollar." A further price spike in energy, he says, "is the last thing a debt-saturated America, embarking on expensive overseas ventures, needs right now. Yet that appears to be where we are headed today, the consequences of which are not yet fully reflected in the markets."