Why oil prices are unlikely to keep falling

published 2 February 2007

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Just as the oil price is slipping back towards the $55 a barrel mark, we get a timely reminder of why our energy situation is so tenuous.

'Russians turn off Europe's oil supply' runs the headline in The Times this morning.

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It turns out that the Russians are using less-than-subtle means to strong-arm a smaller state into accepting the Kremlin's point of view on energy policy.

Readers with a functioning mid-term memory might be thinking they've heard this all before

If stories of Russia cutting off Europe's energy supply are giving you a sense of New Year deja vu, that'll be because it did exactly the same thing this time last year.

In 2006, the Russians were bullying the former Soviet state of Ukraine into accepting gas price hikes. This time, it's the turn of Belarus.

Belarus and Russia used to be chums, but they've fallen out in the last week or so. At the start of the month, Belarus was forced to accept the doubling of gas prices to prevent supplies being cut off.

But Belarus didn't lie down to this. Russia sends more than 1.2 million barrels of oil a day through the hilariously named 'Friendship' (Druzhba) pipeline, which runs through Belarus and supplies nearly 25% of Germany's oil, and almost all of Poland's imported oil.

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So Belarus slapped a tax on Russian oil crossing through the pipeline. The Russians, naturally, didn't like this. And in typically Russian manner, they've just turned the tap off and refused to talk things over until Belarus revokes the tax.

The Times reports, with a touch of understatement: 'The move raised further questions over whether Western Europe can trust Mr Putin for its energy supply. Experts said that Russia had a deeply entrenched habit of manipulating oil and gas supplies as a substitute for diplomatic policy.'

It doesn't take an expert on Russia to realise that when it comes to oil and gas, the Russians have no concept of what constitutes property rights or reasonable negotiation. You only have to read the business headlines over the past year - with the tales of expropriation of Shell's assets, for example - to realise that.

And here's the answer to the first question - no, Western Europe can't trust Mr Putin for its energy supply. That's now two years in a row that supplies have been cut off in the dead of winter. Apologists and appeasers argue that Russia is just trying to get proper market prices out of its satellite states, which have until recently been benefiting from cut-price energy supplies. But the Kremlin is clearly unworried about sending a message to Europe in the meantime.

And what happens when Russia has squeezed a fair market price out of all of its satellite states and then decides that the fair market price for Europeans should be higher?

In the long run, of course, Russia's bullying attitude will backfire - countries will find alternative supplies and suppliers if absolutely forced to, and lets not forget that its own supplies will run out at some point, particularly if it insists on using an inefficient Soviet-era state monopoly to run things.

As the International Energy Agency pointed out, even in a prolonged dispute, refineries can "source crude supplies from alternative routes and some of them are already organising alternative supplies."

But that's the long run. In the short term, Russia's continued politicking is just one of the many reasons why the current softness in the oil price seems highly unlikely to last throughout 2007.

Turning to the stock markets...

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A lacklustre start on Wall Street and weakness in the property sector saw the FTSE 100 end yesterday 25 points in the red, at 6,194. Blue-chip property stocks British Land, Hammerson and Land Securities sustained the biggest losses of the day on negative broker comment. At the top of the leader-board, Cairn Energy rose over 3% ahead of its Indian arm's IPO today. For a full market report, see: London market close (/file/23712/london-close-footsie-drops-through-6200.html)

On the Continent, the Paris CAC-40 gained just one point to end the day at 5,518. In Frankfurt, software giant SAP led the DAX-30 to a close of 6,607,a 14-point gain.

On Wall Street, the Dow Jones ended the day 25 points higher, at 12,423, boosted by software firm IBM. The S&P 500 ended the day 3 points higher, at 1,412, whilst the tech-heavy Nasdaq was 4 points lower, at 2,438.

In Asia, the Nikkei climbed 146 points to 17,237 as traders went bargain-hunting after the holiday break.

Crude oil was trading at $55.68 this morning, and Brent spot was at $54.58 in London.

Spot gold had risen to $612.10 today. Meanwhile, silver had edged up to $12.32.

And in London this morning, shares in BP fell by as much as 1.7% after the oil major revealed that oil and gas production had fallen by 5% in the fourth quarter of 2006, below analyst's forecasts. This is the sixth consecutive quarter than BP's production has fallen.

And our two recommended articles for today...

The Goldilocks economy: no more than a fairytale

- Many experts believe in the Goldilocks scenario, the name given to the hoped-for soft landing of the global economy. But with a hard landing - or even a recession - looking more likely, it may only be the bears which turn out to be real. To find out how likely a soft landing is, read: The Goldilocks economy: no more than a fairytale

Why switching suppliers is worth the stress

- It's all very well getting your investments right, but most of us are losing out by having the wrong broadband, the wrong mortgage or the wrong gas supplier. You may have to brave call centre hell, says Merryn Somerset Webb, but the change is worth it in the long run. To find out how to overcome your phone phobia, read: Why switching suppliers is worth the stress

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He 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.

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.