Why does the price of oil go up?

Iraq's post-war violence is the primary cause of the rise of the oil price. The Iraqi war has spawned so many adverse ramifications in international community that the Bush administration miscalculated the outcome of its pre-emptive attack in March 2003.

Now everyone is paying the high price for this kind of adventure. The global economy could hit recession if oil hits $50 dollars or more and continues for long time.

It may be recalled that in 1999, the price of oil was only at $11 dollars per barrel and the year 2000 saw the price rise to $30.00 per barrel. Since 2000, the price was rising intermittently.

Why does the price rise at present? There are both physical and psychological factors, according to oil experts. Some of them deserve mention as follows:

First, the frequent disruption of oil supply from Iraq and its political instability, Second, rise of terrorist attack in Saudi Arabia and its potential disruption of oil supply, Third, political power struggle in Venezuela (5th oil exporter), and fourth Russia's biggest oil producing company Yukos' uncertainty to supply oil in the context of its looming bankruptcy (Russia exports oil as much as Saudi Arabia per day).

Among other reasons that need mention are: (a) most oil-producing countries have not invested in new machinery in oil installations to pump more oil (Libya, Iraq and Venezuela are examples), (b) The US is buying oil for its strategic reserves for "rainy day," (c) The demand for oil has jumped in China and India to maintain their accelerated economic growth. Import of crude oil has jumped to 40 percent this year in China and the state-run Indian Oil Corporation stated that its crude oil imports rose by 11 percent during this year, and (d) environmental laws in many countries have made oil exploration difficult and limited in search of new oil reserves.

The Vienna-based OPEC is pumping at its highest level since 1979 and a report from OPEC estimates that it may raise its production to 30.5 million barrel per day. According to them, jittery market based on fear psychosis is responsible for the high price.

The US Secretary for Energy has reportedly been occupied with talks with the oil-producing countries to ensure that the price does not remain so high. Media reports indicate that, Saudi Arabia is inclined to increase oil productions to stabilise the world prices in oil. Saudi Arabia's Oil Minister recently said that the steep price of oil should not threaten global economy.

Flow-on effect of price rise
The price of oil has never been a matter solely for the oil-producing countries. The rise and fall of it have profound implications for all the counties in the world. When the oil price is high, it creates inflationary pressures and potentially other economic problems.

The flow-on effect hits every country primarily because the transportation costs increase. The consumers first feel the pinch due to high price of basic essentials including rice, vegetables, fish, and meat. Kerosene oil becomes expensive for poor. Car maintenance and air travel is affected by the rise of price. No sector of economy remains untouched. In the end, consumers spend less on non-essential items and goods. As a result, national economy is badly affected.

For instance, in the US, the consumer spending constitutes two-third of its economic activities. Because of the steep price of oil, there will naturally be a slowdown of consumer spending in the US and consequently, its sluggish economy may have pernicious effect on its economy.

When the oil price rises, the oil-importing countries including Bangladesh suffer while the average income of the oil-producing countries has reportedly jumped almost to 50 percent (the political positions of Venezuela's President Chavez and Russia's President Putin have become much stronger because they can afford to spend more money on national programmes).

However, there is a downside as well for the oil-producing countries. For example, in 1997, the economic crisis hit South-East Asia and North Asia which led to a reduction of demand of oil in those countries. As a result, oil price collapsed in that year, partly because of the economic downturn in parts of Asia.

Relationship of oil production and price
The classical theory says that market mechanisms will adjust price governed by the laws of supply and demand. It has been reported that ordinarily the demand for oil worldwide increases at an average annual rate of 2 percent (at present on average demand is more than about 9 percent) At that rate of increase in demand and with matching supply, experts maintain that an equilibrium price will be at least around $30.00 per barrel.

When the price is low, the oil-producing countries and oil companies suffer. If the oil price is as low as $20 dollars, investment in oil exploration and production is not cost-effective. Oil experts say that in order to reach a viable stage for oil exploration companies, the oil price must rise at least $25 dollars.

The experts believe that the depletion of existing oil wells is about 10 percent per year and to produce an extra million barrels per day it requires investment of $3.5 billion to $7 billion. It is estimated that the oil companies spend $100 billion per year to replace lost production and to meet the incremental demand.

The question is : from where does the money come from? It must come from the oil price at a rate that matches the expenses of additional oil production.

It appears that given the dynamics of need of continuing oil production and its demand, experts believe that oil price will continue to be above the $35 dollars per barrel in the coming years. Some experts say that it may hit $60 dollars per barrel, if the unabated demand in China continues without having any new oil reserves.

Oil prices are unlikely to fall at $30 dollars soon. The days of cheap oil have gone and the oil-importing countries should be prepared to pay for high oil prices. The adage that, what goes up must come down, does not appear to be applicable in respect of oil price.

Conclusion
To avoid dependency on oil, environmentalists, such as Canadian David Suzuki, suggest that the need of designing a new kind of global economy which is not dependent on oil and other fossil energy. Renewable energy including solar, wind, tidal and geothermal should replace the fossil energy. The industrialised countries have not spent money on alternative clean energy resources anywhere near the funds that go into space exploration. The International Space Centre in the US alone is expected to spend about $100 billion in near future.

It is now time that the industrialised countries direct their attention to search for and develop renewable energy resources, otherwise the high oil price will have adverse impacts on poor countries. The poor countries will be compelled to divert their resources away from social including poverty alleviation programmes. One must be conscious that poverty creates unemployment and desperation among youths that is likely to be exploited by extremists for their political agenda to destabilise the world.

Barrister Harun ur Rashid is a former Bangladesh Ambassador to the UN, Geneva.