Even more pain at the pump this year

I am usually loathe to predict what oil prices will do, certainly in the long term. As Yogi Berra famously said "it's hard to make predictions, especially about the future". But some pretty compelling evidence suggests another substantial upward tick in the oil price is coming in the second half of this year - on top of the already damaging current oil price shock.

International Energy Agency desperate

For years now the IEA has issued coded messages about the looming oil crisis such as "the era of cheap oil is over". But lately their statements are becoming ever more strident and urgent.

Their June 2011 report states quite plainly that unless OPEC can increase production by at least 1.5 million barrels a day, the world faces a supply/demand mismatch and price crunch in the second half of 2011. If supply cannot meet the expected demand of 89 million barrels a day this year, prices at the pump must rise again -- and sharply.

A sure sign of the IEA’s desperation was its recent decision to release 60 million barrels from members strategic reserves (New Zealand was exempted from this requirement because our stockpiles are so tiny.) 60 million barrels amounts to just 16 hours of world oil demand.

Not surprisingly the IEA release held down prices for only a week. They have already returned to pre-release levels. The strategy failed for the very reason warned about in their June report – the oil markets expect demand to exceed supply -- and soon.

OPEC upheavals continue

It is not looking likely that OPEC can increase supplies. At best Saudi Arabia can only offer heavy sour oil when the world wants light crude oil such as Libya could produce. There are no signs of an end to conflict there. And as noted before -- the excess capacity Saudi Arabia is purported to have is of the fictional variety. Attacks on oil infrastructure have increased in Iraq as US forces are set to withdraw.

Asian oil demand still on the rise

China has a major drought affecting hydro generation, and Japan has had a nuclear meltdown. Although these economies are slowing both have major power shortages forcing them to burn more diesel, leading to more demand for oil.

Convergence

All these converging trends point to an oil price crunch in the next few months. This leaves the IEA with a quandary. Will it release more oil from strategic reserves and repeat its failed strategy of just a few weeks ago?

Consequences?

We have been saved from even higher pump prices by the record high of the NZ dollar against the US dollar.  Even so, average fuel prices in New Zealand are already above those seen in the last oil shock of 2007- 08. 

Also, prices have already reached levels which historically have induced recessions.The IEA's January 2011 Oil Market Report uses the term ,“oil burden”, to quantify how higher oil prices impact the global economy. Oil burden is defined as global oil expenditures divided by global GDP.  At $100 per barrel the oil burden is 5 per cent .  Prices have been above this level for months - a level which historically causes a global recession. And the IEA warns that import‐dependent developing countries (read New Zealand) are particularly vulnerable.
 

Good news -- bad news

The "good news" is that oil prices may well fall sharply if we see a repeat of the demand destruction in OECD nations in 2008- 09

The bad news is that it will take another oil-induced global recession before demand is reduced and causes prices to fall again.

Happy days indeed