Why is the oil price so high?

This feature is part of our FREE daily Money Morning email. If you’d like to sign up, please click here: sign up for Money Morning

Oil is back in the headlines again.

It’s about time, quite frankly. The oil price has now been solidly above $70 a barrel for a long time, and it’s heading for a new record, even though there’s not a hurricane in sight.

So what’s behind the rise? Hedge funds? Jittery investors? Geopolitical tension?

Nope. Energy watchdog, the International Energy Agency, puts it down to one thing.

Supply and demand, pure and simple…

The International Energy Agency reckons that the world will face an oil supply crunch within the next five years, that could send prices soaring even higher than they are today.

With global economic growth of 4.5% a year forecast, the IEA estimates that oil demand will hit 95.8m barrels a day by 2012, from 81.6m barrels a day this year. But at the same time, oil cartel Opec’s production is expected to fall 2m barrels a day by 2009, while non-Opec supply will be down 800,000.

Lawrence Eagles, the refreshingly plain-speaking head of the IEA’s oil industry and markets unit told The Telegraph: “The results of our analysis are quite strong. Either we need to have more supplies coming on stream or we need to have lower demand growth.”

He flatly denied that the agency was being overly pessimistic, as some commentators claimed. “The price response is due to fundamentals. We are simply pointing out the fundamentals – that’s our job.”

Among the IEA’s many worries is ‘energy nationalism‘. Governments such as Russia and Venezuela are effectively confiscating assets from private companies and handing them over to nationalised ones. Regardless of where you stand politically on the rights and wrongs of this, the simple truth is that a nationalised oil company is not as good at getting oil out of the ground as a private operator.

The more oil fields that fall into national hands, the less efficient the global oil infrastructure will become. And that inefficiency will bring the day that oil peaks ever closer.

The optimists are still clinging to the notion (as they have been for a couple of years now) that oil will somehow settle at around $40 a barrel, any day now. But the chances of seeing $40 a barrel again any time soon seem truly remote from these heights.

Part of the resistance to the idea of Peak Oil is that it’s very difficult to envisage a world where energy scarcity is a genuine problem. We tend to assume that human ingenuity and economics will combine to find a solution. And we’re sure it will – eventually.

But in the meantime, too many of us are still underestimating the sheer level of demand growth that the world is facing. As Jeroen Van der Veer, chief executive of Royal Dutch Shell says: “China and India are entering the energy-intensive phase of their development. This is the point when people buy their first television or car, or board a plane for the first time.”

As The Telegraph’s Tom Stevenson adds: “Given the developed world’s addiction to oil, what is surprising is not that China’s oil demand is doubling every 10 years, but that it is not growing even faster.”

Meanwhile, the rising oil price may bite much sooner than 2012. As think tank Capital Economics points out, rising energy costs will put even more pressure on the Bank of England to raise interest rates. “The key point… is that oil and petrol prices no longer seem likely to have the downward impact on inflation that had previously seemed likely… this obviously suggests that inflation is not going to fall as steeply over the summer as had seemed likely just a few months ago.”

And with other input costs rising sharply – annual input cost inflation jumped to 2.1% in June, from 1.3% in May – companies are unlikely to heed the Bank’s warnings to rein in price increases. They simply won’t have a choice.

But of course, there are ways for investors to gain from all this. Both FTSE 100 oil majors, BP and Shell, look cheap at current levels – and the City is starting to recognise it. If you’ve not already bought into them, it might be an idea to do it soon – before everyone finally figures out that the oil shortage isn‘t just going to go away.

Turning to the wider markets…


Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email


In London,the blue-chip FTSE 100 ended the day 81 points lower, at 6,630, and the broader indices were also down. Marks & Spencer was the day’s second-highest climber on better-than-expected results, whilst bid speculation helped consumer goods giant Unilever to the top of the FTSE leaderboard. However, mining stocks dominated the fallers. For a full market report, see: London market close.

On the Continent, the Paris CAC-40 closed down 85 points, at 6,019, and the Frankfurt DAX-30 was 112 points lower, at 7,964.

On Wall Street, the Dow Jones tumbled 148 points to end the day at 13,501. The S&P 500 was 21 points lower, at 1,510. And the tech-heavy Nasdaq lost 30 points to close at 2,639.

In Asia, the Nikkei was 203 points lower, at 18,049, today.

Crude oil climbed above $73 yesterday but had fallen back to $72.59 this morning. In London, Brent spot was at $77.27.

Spot gold hit its highest level in a month – $665.70 – but had since slipped to $665.50. Silver, meanwhile, was at $12.95.

In the currency markets, the pound was at 2.0281 against the dollar and 1.4756 against the euro this morning and the dollar was at 0.7274 against the euro and 121.35 against the Japanese yen.

And in London this morning, BSkyB beat forecasts by adding 259,000 broadband subscribers in the fourth quarter. The company began bundling internet access with its TV packages last year in order to counter rivals Virgin Media and BT. Shares in BSkyB were up by as much as 2.7% in early trading.

And our two recommended articles for today…

Banks send out a strong signal on the property market
– Some of the UK’s major banks, including HSBC, have been selling off their expensive headquarters in order to lease them back. Could this be a sign that we’ve reached a property market top? And why is the financial sector itself looking so shaky? To find out read:
Banks send out a strong signal on the property market

How to profit from the return of the railways
– Famous investors Warren Buffett and Carl Icahn have both bought shares in railways recently. With trains coming back into fashion around the world, should you join them? For more from Chris Mayer on a rail revival, read: How to profit from the return of the railways