Why did oil prices make new highs this week?
The above graph displays the price of the September 2005 NYMEX light crude contract over the
last five months. Two weeks ago, href="http://www.econbrowser.com/archives/2005/07/the_week_in_oil.html">I commented on a
significant move down in oil prices, attributing it primarily to the dramatic arrest of the
previously spectacular growth of Chinese oil demand. Beginning July 21, that downward move
abruptly ended, and oil prices have been climbing steadily since. By today, the effects of the
earlier downward trend had been completely erased.
One possibility is that the market
href="http://www.resourceinvestor.com/pebble.asp?relid=11345">developed doubts about the
accuracy of the new Chinese data, with href="http://theoildrum.blogspot.com/2005/07/simple-but-discouraging-arithmetic.html">the Oil
Drum quoting the Oil and Gas Journal as still predicting 8.2% growth in Chinese
demand for petroleum products in 2005 and 6.7% for 2006. On the other hand, Morgan Stanley’s
Asian specialist Andy Xie continues to cheerlead for the oil bears. According to the LA Times,
[Xie said] demand for oil imports this year had dropped in China, India, South Korea, Taiwan and
Thailand, countries that account for 16% of world usage and made up 44% of last year’s increase
in consumption. The reason, Xie said, was weakening economies and the use of other
I frankly profess to be puzzled by these conflicting analyses, and in any case don’t see why
such disagreements would be manifest in first a steady drift down and then a steady drift back
up. By contrast, the market’s reaction to yesterday’s news of the death of Saudi’s King Fahd
made immediate sense to me. Although the majority opinion might be represented by href="http://newerainvestor.blogspot.com/2005/08/is-death-of-king-fahd-important.html"> New Era
Investor’s conclusion that nothing had really changed in Saudi Arabia, I was more inclined
to share the thoughts expressed by Soj at href="http://www.dailykos.com/story/2005/8/1/16212/59104">Daily Kos:
[T]he way I see it, Abdullah and his allies are just one forced abdication or assassination away
from being replaced by Sultan and the more conservative, anti-western Saudi
Spectator spelled out the implications of this scenario in further detail:
“This is the largest royal family in the world and there will be a struggle as princes compete
for positions of power,” Mai Yamani, who watches the Middle East from [her] post at the
London-based research center Chatham House, tells href="http://www.bloomberg.com/apps/news?pid=10000087&sid=aOKZFwUVxs4c&refer=top_world_news">
The Saudi kingdom, home to a quarter of the world’s known oil reserves, is a powder keg
waiting to explode. When it explodes, and by how much is the question. To be sure, the heavy
hand of the royals has kept the would-be revolutionaries from lighting the fuse. How long can
they keep it up?
If a full-fledged conflict were to emerge over the succession of power after Fahd, or after
Abdullah, it would have the potential to generate an oil shock that would make all the episodes
the world has seen up to this point look like a walk in the park. Even a fairly small
probability of such an event would be enough to justify a substantial price premium. For
example, if there is even a 5% chance of oil going to $140 a barrel within the year, that
possibility is enough to justify a $4 increase in the price of each barrel of oil: [(140 - 60) x
(0.05) = 4.0].
Worries like that could easily explain oil’s price rebound, I’m thinking. But nobody had a
clue about the king’s death before Monday. Or did they?
Perhaps you recall
from July 20, just before oil prices started their move back up. It was an account about
Prince Bandar, Saudi Arabia’s longtime ambassador to the U.S. and one of the most influential
Saudis in world politics:
The Saudi Foreign Ministry said Bandar– who had held the post for 22 years but
had been out of Washington for most of the past year– was stepping down for “personal
Bandar’s resignation coincides with looming changes in Saudi Arabia’s ruling hierarchy. King
Fahd is seriously ill. Crown Prince Abdullah, who has been de facto ruler during Fahd’s long
illness and will become king after Fahd’s death, is expected to name Prince Sultan– Bandar’s
father– as the next crown prince.
That Bandar was stepping down for “personal reasons” I greatly doubted at the time. In
retrospect, it is abundantly clear that this was all about preparation for the Saudi power
succession. I can easily suppose that, although I was not sufficiently clever to connect all
the dots at the time, others might well have been.
For those of my readers who are convinced that markets can never see past the end of their
nose (and I know you’re out there), attributing this degree of clairvoyance to oil traders will
seem nothing short of fantastical, and I must admit that I find it a surprising possibility to
consider myself. But I have seen something similar happen many times before in other markets–
a stock price starts drifting up for a few weeks, and you can’t find a word of coherent
explanation in the popular press at the time, but then later there appears a big news story that
turns out to justify completely what the stock price had been doing all that time.
Speaking of dissing the market’s wisdom,
href="http://theoildrum.blogspot.com/2005/08/letter-to-senator-schumer.html">the Oil Drum
reports on Senator Chuck Schumer’s (D-NY) fortunately unsuccessful efforts to include in the
energy bill language that would have encouraged the Department of Energy to use the Strategic
Petroleum Reserve in order to bring some relief to consumers who are paying too much for
gasoline. It’s perhaps a little unfair to the senator to attack him on this with pure logic,
but I can’t resist the impulse to do it anyway. It makes no sense to blame the current oil
price on the OPEC cartel, since OPEC production has increased, not decreased, as prices have
gone up. If we attribute the high oil prices to strong global demand, then the only way to
bring that demand down is with higher prices. If we attribute the high prices to a risk premium
arising from concerns such as a possible civil war in Saudi Arabia, we darn well better keep
that oil in the SPR because the market is saying we might soon need desperately to draw on the
SPR for its original intended purpose. If we attribute the high prices to href="http://www.econbrowser.com/archives/2005/07/how_to_talk_to.html">the impending arrival of
global production peaks, then we absolutely need those high prices to keep western
civilization running. And if we attribute the high prices to the irresponsible actions of
reckless speculators, well, then oil prices are soon going to crash on their own without needing
any assistance from the senator or anybody else.
Other than that, Senator Schumer, your suggestion makes perfect sense to me.