Oil prices:Factors that have pushed the price of Brent crude close to $100 a barrel this year look set to persist during 2008, writes Paul Harris.
The last 12 months will be remembered as the year when oil prices narrowly failed to reach the landmark $100 a barrel.
The price movement that led us to within striking distance of this milestone was difficult to predict as Brent crude began the year about $56 a barrel. Fast forward to December and Brent now sits about $93 a barrel, having touched an all-time high of $96.34, some 66 per cent higher.
How did we get here and how instructive is the past year in terms of what 2008 has in store for crude oil prices?
The key price driver for oil is the supply-demand gap. Since 2002 oil prices have registered successive annual increases with global economic growth the main driver increasing daily oil consumption to about 86.1 million barrels. China and India have continued to record phenomenal growth rates of about 10 per cent and, with their insatiable appetite for oil, and crude stock levels in the US remaining at significantly low levels, the demand-supply gap has remained under pressure throughout 2007.
On the supply side, geopolitical risk is a prominent price driver. Events from the heightened unrest in the Niger Delta earlier in the year and the destabilising impact in the Middle East of the Hamas action in Gaza have led to periodic price spikes.
The Iranian uranium enrichment dispute was the backdrop to price action for much of the year. The failure of a negotiated settlement led to a hardening of positions on both sides and fears that the dispute would escalate has kept prices up.While the latest US intelligence reports have served to allay fears, the Iran factor will continue to exercise the market in 2008.
Very much in evidence this year was the downtime and essential maintenance that beset the refining industry. Pipeline faults meant extended periods of little or no production which added to the bullish tone of the market.
The problem here is a chronic lack of investment which has led to refineries in a poor state of repair having to run at capacity for long periods to meet demand. This is a systemic problem which will remain influential throughout the year ahead.
2007 will also be notable for the consolidation of the reputation of Opec, the cartel to which the market looks for price signals. The organisation is becoming disciplined with clear ideas on where prices and output should be. They stood resolute when the US and others were pressing for supply increases as global oil prices flirted with $100 a barrel.
Opec moved to protect their purchasing power in the face of a falling dollar, yet delivered a token increase to assuage international pressure. The cartel has long maintained that the sharp price rises were down to speculative action and that global supply was adequate.
But, perhaps the most important impact on oil prices this year had little to do with supply and demand. Speculators have played a part in price moves to a much greater extent than ever before. The increased level of investor funds into oil has much to do with the out-performance of commodities over equities but the failing dollar is also implicated.
As the subprime crisis began to rage in August, players hedged the weak greenback through the oil markets pushing oil to record highs (and the dollar to record lows) and for much of the remainder of the year oil prices have been very much bound to the fate of the dollar.
2008 will inevitably see oil prices breach $100 a barrel as factors that have dominated the market continue to exert an influence.
Global growth is forecast to remain about 5 per cent, ensuring buoyant demand for oil globally. The malaise in the dollar will also endure - simultaneously lending a bullish tone to oil throughout 2008 and continuing to immunise Europe against the impact of higher prices. Commodity markets will continue to attract investment in preference to equities, adding to price volatility.
Opec faces a challenging year trying both to foster continuing global demand while tackling growing demands within the cartel to move pricing away from the ailing US dollar.
Geopolitical risks will remain with Iraq and Iran the focus of continuing vigilance. Additionally, statistical analysis of historic Gulf hurricanes fosters the belief that the coming season will prove more threatening than recent years, prompting fears of problematic supply and consequent price impacts.
With new supply from both the Middle East and Angola set to begin flowing early in the first quarter of 2008, prices may recede initially. However, if global growth remains constant and oil demand growth continues to increase, geopolitical and climate-related events will ensure that crude prices maintain upward momentum.
Brent crude is likely to average $83 a barrel in 2008 with $100 a barrel set to lose its talismanic status as fundamentals and speculative pressures drive oil ever upwards.
Paul Harris is Head of Natural Resources Risk Management at Bank of Ireland
