Saturday, August 21, 2004

Exactly how many of oil's forty-eight-plus dollars today are made of nothing but ephemeral froth and speculation? The World Bank's chief economist Francois Bourguignon thinks more than a third of them.
The chief economist of the World Bank predicted in an interview that oil prices would return in a matter of months to a stable level around 30 dollars a barrel after hitting record highs this week of nearly 50 dollars.

Although prices closed down on Friday, many traders predicted that the volatile hikes would continue, but the World Bank's Francois Bourguignon said that, once current uncertainties have dissipated, "I think we will return to a balanced price in a few months' time."

Bourguignon told the Spanish economic newspaper Cinco Dias that market forces would eventually stabilize the price. For example, producers would exploit wells that are not profitable at 30 dollars a barrel, but might be at a higher price. But then an increase of supplies would have the effect of driving the price down again.

He said there were undoubtedly some objective causes for the price rises, such as China's strong growth and economic recovery in the United States and Japan.

However, he said the price rise was also fuelled by speculation and uncertainties over the fate of the Yukos oil conglomerate in Russia or the referendum in Venezuela. He discounted the crisis in Iraq because it had not been an important oil producer before the US-led occupation last year.
Moving into the northern hemisphere's winter, this is a pretty bold prediction. Political instability in many oil-producing countries, especially Iraq and Nigeria (but don't count out Saudi Arabia and Venezuela), promises to be a long-term phenomenon. Moreover, the good M. Bourguignon has no appreciation for the "animal spirits" of the market which have truly become unleashed.

However, Bourguignon does have several things on his side. The slowing US economy should (I emphasize should) reduce consumption as should the supposedly slowing Chinese economy. OPEC surge capacity can come into production to deliver a temporary downward jolt, as could a big release from the US Strategic Petroleum Reserve.

But let's assume that hedge fund speculation can somehow be magically removed from the market. The Financial Times today suggests that NYMEX prices would come down only to around $40/barrel, not M. Bourguignon's $30.

The big conclusion of course is that even if oil fell to $30/barrel, that would still be above the old OPEC price ceiling by $2 as well as above anything the world has seen for a sustained period since the early 1980s when Ronald Reagan and James Baker defanged OPEC. The Clinton-era boom wasn't just built off of Robert Reich's "symbolic analysts". It was also built off extra-large current account deficits and ultra-low oil prices. The latter are gone for good, and the former is now an albatross around the neck.


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