WORLD OIL PRICES AND THE WAR ON INFLATION

TIGHT SUPPLY SITUATION AT THE BACK OF PRICE HIKE

SHAMSUL GHANI (shams_ghani@hotmail.com)
Mar 31 - Apr 06, 2008

The last six months have seen a steep rise in the oil prices. Till early September last year oil was trading below $70 a barrel in the wake of US sub-prime mortgage fiasco. As a consequence of some half hearted US measures, the sub-prime pressures eased and the oil prices resumed upward flight. The measures did not prove effective enough and the crisis erupted again pushing the US economy in turmoil. The depreciating dollar made the speculators move to some more attractive markets like gold and silver. The investment in the world oil sectors could not keep pace with the rising global demand for oil.

On March 17, the US crude closed at history's highest price level of $111.80. Since then the crude prices have maintained the $100 level. A few downward slides now and then raise false hopes of a sustained market correction, but then the prices abruptly shoot back in a threatening style. The following table shows the movement of prices during the last three weeks:

Date New York's main contract for light sweet crude (US$ per barrel)  London's Brent North Sea crude (US$ per barrel) DELIVERY

11-03-2008

109.72

105.82

April

12-03-2008

109.85

106.39

April

13-03-2008

110.33

106.59

April

14-03-2008

109.96

106.97

April

17-03-2008

111.80

103.48

April / May

18-03-2008

107.72

104.20

April / May

19-03-2008

105.20

101.29

May

20-03-2008

101.22

100.08

May

24-03-2008

100.86

99.86

May

25-03-2008

100.64

99.84

May

26-03-2008

105.09

103.49

May

It was in November 1998 when the oil prices hit last decade's lowest at US$ 11 per barrel. Thereafter, for a few years, the prices moved between $28 and $40. It is during the last five years that the prices have more than tippled. This week, gasoline inventories fell by 3.3 million barrels in the wake of a slowdown in the US refinery operations. Distillates also dropped by 2.2 million barrels. Crude oil inventories expected to increase by 1.7 million barrels also remained unchanged as compared to the last week.

The dwindling investment in the refinery sectors of the major world oil producers has kept the world production below the required level giving rise to the speculative changes in the oil price structure. On the geo-political scene, the Afghanistan, Iraq and Iran crises triggered by the US hegemonic policies have also contributed to the worsening of the situation.

In the words of George Soros, the well known hedge fund manager, "The core of the crisis is the tight supply situation for oil." Recently, the US Vice President Dick Cheney and Saudi King Abdullah held a five hour long "confidential and private conversation" to develop consensus on short, medium and long term measures to stabilize the market. One shudders to think of the alternatives in case the supply position is not eased to the liking of the world bosses.

Alan Greenspan, the former US central bank head admits in his recent book, The Iraq war is largely about oil. "One can expect a similar statement on "Iran and Venezuela Wars" from an American writer a few years from now. This may sound cynical but a mere glance at the following simple statistics may reveal a lot to the discerning mind.

REMAINING PROVEN OIL RESERVES

PRODUCER

RESERVES TO LAST

Middle East

80 years

Venezuela

78 years

Kazakhstan

70 years

Africa

32 years

Russia

22 years

China

12 Years

United States

12 years

THE INFLATION AND THE CHALLENGES AHEAD

The European Central Bank Chief Jean-Claude Trichet recently said, "If we don't learn the lessons of the past we will find ourselves faced with the same problems that we encountered during the first oil crisis (in 1973) when government responded to higher prices by raising wages and salaries. That fuelled an inflation spiral, choked off growth and caused widespread, stubborn unemployment that dogged Europe for decades."

Pakistan is also faced with a similar situation. Any economic window dressing by the newly installed setup may create a mayhem situation. As they say, "Inflation is the long-run accumulation of short-run expediencies. More dangerous than inflation is the inflation psychology. The battering ram of inflation has crushed the masses who find themselves enveloped in this psychology. The new government needs to restore their confidence in the free market economy and democratic forces. They should remember the German hyperinflation of 1923 when German citizens used wheelbarrows to carry their money having very little purchasing power. This situation culminated in the rise of Hitlerism.

The following illuminating lines from Steven Solomon's The Confidence Game should carry a few lessons for the new rulers:

"Inflation psychology was the obverse of the lost confidence that marked the Great Depression. Both inflation and depression, instability upward and instability downward, could destroy capitalist society and with it, the economic prosperity and transparency conducive to democracy. Inflation allows the politicians to make promises that can not be met in real terms . [It] becomes the means of promoting changes in our economic, social, and political institutions that circumvents the democratic process."