Oil at $100/bbl would harm economy

Sam Fletcher
OGJ Senior Writer 

Financial markets and the Organization of Petroleum Exporting Countries are repeating their 2008 mistake in assuming the world can live with $100/bbl oil, said Olivier Jakob at Petromatrix, Zug, Switzerland.

There is food price inflation in emerging countries, and when fuel inflation is added, domestic unrest develops. If food riots become a recurring pattern, Jakob expects the US Federal Reserve to come under more pressure “to limit its policy of wealth creation through the inflation of risk assets (including commodities).”

He noted, “On Dec. 27, Bolivia increased the price of fuels (up 83%); on Jan. 1 it reversed the decision after street protests. On Jan. 1, Pakistan increased the domestic price of fuels; on Jan. 6, it reversed the decision for fear of street protests.”

Meanwhile, there have been riots in Algeria over food prices. India needs to increase domestic fuel prices but does not dare, with food inflation already at more than 18%. “Oil prices approached $100/bbl at the end of 2007 and were followed by food price riots in the first half of 2008. Oil prices approached $100/bbl at the end of 2010 and are starting to be followed by food price riots,” said Jakob.

Politics and prices
Paul Horsnell at Barclays Capital in London expects oil to be a political issue in 2011, particularly in the UK where retail prices are at new highs due to increased taxes. “In the US, the current national average of $3.07/gal for regular gasoline is still $1.04 below the peak reached in 2008,” he said. “While $3/gal still has a certain sticker-shock, arguably it would be an approach towards $4 that would create a more significant political back draft. However, in the UK, the 2008 peak of 119.44 pence/l. was overtaken at the start of December 2010. The first data of 2011 from the UK Department of Energy and Climate Change put the average at 124.85 pence/l. and since then the rate of [value-added tax] has increased from 17.5% to 20%, which, other things being equal, will take the price above 127 pence/l.”

Horsnell noted two main factors for the rise in UK prices to new peaks in sterling. “The first has been the strength of the dollar against sterling relative to 2008,” he said. “At the 2008 peak for crude oil prices, UK gasoline prices were equivalent to $9/gal at the then ruling exchange rate, whereas today the dollar comparison is closer to $7.50/gal.”

Jakob said, “The dollar index was up strongly Jan. 6, but that was mainly due to the euro falling hard on continued worries about the peripheries (the dollar to Swiss franc and to the yen was basically unchanged).”

The second factor in higher prices was “first the ramping-up of excise taxes and then the latest increase in VAT,” Horsnell said. “Put higher taxes together with adverse exchange rate effects and the recovery of the underlying oil market, and the momentum has been there to exceed the 2008 peak by some 7% and create a sharp and highly visible escalation in the cost of filling a gasoline tank.”

In London, the February IPE contract for North Sea Brent crude traded as high as $96.12/bbl on Jan. 3, the first trading session of 2011, before closing at $94.84, up 9¢ for the day. On the New York Mercantile Exchange the February contract of US benchmark crude was up 17¢ to $91.55/bbl. Both seesawed up and down through the week with Brent closing at $93.33/bbl on Jan. 7 and WTI at a 3-week low of $88.03/bbl.

West Texas Intermediate “has dislocated again, with weak prompt time spreads and extreme loss of relative value against other crudes,” Horsnell said. On Jan. 6, the price spread between WTI and Brent widened to $6.14/bbl in Brent’s favor. But price discounting of WTI was overdone, “in part an overreaction of expectations about logistical changes that do not merit so large a price response,” Horsnell said.

(Online Jan. 10, 2011; author’s e-mail: samf@ogjonline.com)

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