Is the oil price heading for $200 a barrel?

published 24 February 2011

Oil prices are well into 'danger' territory already.

This morning, Brent crude is around $115 a barrel. WTI the US benchmark is trading at around $100.

And small wonder. With the situation in Libya continuing to deteriorate, analysts are getting worried about the potential for civil war. Oil production in the country has already fallen in half according to some reports. All-out civil war could see it stop altogether.

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So how bad could it get?

Why the current oil spike is different to 2008

We know that high oil prices are bad for the global economy. It drives up everyone's costs. Very few people benefit apart from select companies in the energy sector. So it's no surprise that stock markets are in turmoil.

But the last time oil prices spiked like this, back in 2008, they went on to collapse. From a summer high of nearly $150 a barrel, they tumbled to $30-odd a barrel by the end of 2008. Won't we see the same again?

It's a reasonable question. The trouble is, the two situations are very different. In 2008, we had a demand-driven oil spike. The developed world was running into trouble, but demand for oil in emerging markets was still growing. Loose monetary policy didn't help either.

That demand was pole-axed when the credit crunch hit. Global trade dried up practically overnight, as the credit to fund it vanished. Export economies were particularly hard-hit over the next year. So you can see why oil prices went into freefall.

This time the problem is supply, not demand. Libya's oil production has been cut in half, according to some reports. So even although higher prices should act to reduce demand, that's not the key issue here. The real fear is whether more supply will be knocked out. And on that front, the outlook isn't great.

How high could the oil price go?

The best case scenario is that the protestors win, kick out Gaddafi, and restore calm and production quickly. Almost anything else is likely to make matters worse. A prolonged civil war would just mean more disruption. A former CIA officer tells Bloomberg that "civil war is most likely unless someone assassinates Gaddafi". He and his supporters "are going to hold onto a part of the country, an armed force with a lot of money".

And as Javier Blas points out in the FT, if Gaddafi wins, that's going to put the West and by extension, Western oil companies in an untenable position. I'd like to think that we can't go back to propping Gaddafi up after this. While the national oil company would no doubt take over any abandoned assets, history suggests that production would fall.

How bad could it get? Analysts at Nomura have put together some scary predictions. They compare the current disruption with the 1990-91 Gulf War. "It is the only event in the Middle East which seems close to the current crisis during the free-market pricing era." During that period, the oil price more than doubled going from below $20 a barrel to a peak of $41 (amazing to think that was seen as expensive back then).

Prices started to climb on the mere threat of disruption by about 20%, not dissimilar to today. But the major spike came when actual disruption took place during the war. If prices took a similar path during this crisis, says Nomura, "we estimate oil could fetch well above $220 a barrel".

Now, that's assuming that Libya and Algeria both stop production. And I'll admit right away that when I see headline-grabbing forecasts like this, my inner cynic immediately thinks: "we can't be far from the end of this panic".

Saudi Arabia is bribing its population

But it's hard to see this turmoil ending soon. Saudi Arabia is now reportedly spending $36bn on handouts in an attempt to keep its people on the straight and narrow. And it's not just the Middle East and North Africa. The Chinese are ardently denying that there's any chance of a revolution there, which shows that they must be worried. There are reports of uprisings and protests everywhere from Cameroon to even North Korea.

And even if oil prices go nowhere near $200 a barrel, current levels are more than high enough to hurt. It's a very mundane point to make, but petrol prices are already at incredibly high levels here in Britain. And that can't be helping 'the recovery'. Forget vague fears of 'the cuts' and higher VAT. If consumers are feeling less confident and spending less, then it's because of the price that they're paying at the pump. That's a concrete, significant, highly visible cost which is rising by the day.

As Nobuo Tanaka of the International Energy Agency put it to CNN, at $100 a barrel, "the burden of oil to the global economy is as bad as 2008 and remember 2008 was the crisis year".

I can't see the oil price collapsing in the near term. If you're interested in trading it, you could look at spread betting if that interests you, then sign up for our free MoneyWeek Trader email, where John Burford gives tips and tactics on how to maximise your profits). You could also consider a short-term trade using an exchange-traded fund that tracks the oil price, but do be careful. Make sure you understand how they work before you invest in one, and keep an eye on the performance they aren't 'buy and hold' investments. The surging oil price will have plenty of other consequences and we'll be looking at these in a forthcoming issue of MoneyWeek magazine. If you're not already a subscriber, subscribe to MoneyWeek magazine.

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John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.