Fuel's gold

Oil prices

Mar 10th 2005
From The Economist print edition

Heading for new peaks

CRUDE-OIL prices flirted with a new high this week. West Texas Intermediate (WTI) reached $55.65 a barrel, on March 9th, just shy of the record, $55.67, set last October—although in real terms the price is well below its highest ever. The price rose on a blast of cold weather in Europe and America, which has boosted oil demand. The dollar, in which oil is priced, has also fallen to a two-month low against the euro. Both events have attracted speculative money. The New York Mercantile Exchange reported that this week an option with a strike price of $100 a barrel was traded for the first time.

Underlying oil demand is also stronger than expected. A report this week by America's Department of Energy forecast that oil prices would average $48.95 a barrel this year, 14% more than it predicted in January, and $47.05 in 2006.

The oil market shrugged off news that American crude-oil stocks have risen to their highest level since July. This rise partly explains why OPEC members are unlikely to decide to increase their production when they meet in Iran on March 16th. Prices have risen by more than 20% in the past month, but members are worried that energy demand will dip as the northern hemisphere moves into spring.

OPEC formally suspended its old price target (based on an average of various oil prices) of $22-28 a barrel in January. The fact that OPEC cut production when this average fell to $34 a barrel in December suggests a new higher target, implying something around $40 for WTI. There are two reasons for this increase, suggests Simon Hayley of Capital Economics, a London research firm. A falling dollar has eroded the value of OPEC's revenues: although the oil price has doubled in dollar terms since April 2002, it has gained only 30% in euro terms. If the dollar continues to weaken, it will strengthen OPEC's desire to keep dollar oil prices high.

A second reason why OPEC has raised its price target is that the fear that higher prices will choke off world growth, and hence oil demand, has also faded. Despite high prices, last year the world economy grew at its fastest rate for a quarter of a century. This underlines the fact that oil prices have been driven higher largely by an increase in global demand, especially in China and America, rather than by a supply shock, as happened in the past.

China could decide the fate of the oil price over the next year. It has accounted for one-third of the rise in global oil demand since 2001. If China's economy continues to boom, its energy demand will keep on surging. But if China stumbles, expect oil prices to tumble in turn.

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