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Fundamental and Temporary Reasons for the changes in the oil prices
by Bahman Aghai Diba


March 07, 2005

The price of oil has faced dramatic changes in the last year. The prices have increased almost 60%. A part of this increase was foreseeable since a while ago. There are several basic and temporary issues that have affected the oil prices. The elements that have the basic role in the oil prices are:

1- The increase in the pattern of oil demand in the USA following a comparative economic recovery in some industries has affected the oil prices. The more extensive economic recovery in the USA, and its impact on the economy of many other countries of the world, will add to the demand for oil and if the supply side does not provide additional sources, in a considerable way, the prices will stay high or go even higher.

2- Increase of the economic growth and industrialization in many countries of the world has a direct impact on the demand for oil. The new industries all over the world call for more energy.

3- The Considerable economic growth of several Asian countries, especially India and China, are a major part of the price hike story. These two countries are home to 2.5 billion people. Their industries are thirsty for energy. In recent years, the Chinese have converted many of their coal based industries into oil based ones and this has added to the increase in the demand for oil in China. Only in the last one year 36% is added to the Chinese oil imports and the China is now the second biggest oil importer in the world. The rapid expansion of the Chinese market is so considerable that even the American refineries prefer to sell their products in China, which has led partly to the increase of the gasoline and gas prices in the USA. Outsourcing, or the policy of sending the economic operations out of the original country, especially in the case of the USA, has helped the economic growth of the India and China. The new members are getting added to the receiving side of the outsourcing, and especially Vietnam, Cambodia and Laos are in the line.

4- The situation of Iraq in general has special importance. The Situation of Iraq is in fact source of many concerns for the oil market. Some of these concerns are:

(A) The flow of the Iraqi oil to the market,
(B) The outcome of a unilateral policy of the USA in the region,
(C) The future of democracy or chaos in Iraq,
(D) The implications of European and Russians ouster from the Iraqi economy,
(E) The extent of success of the US military operations due to the events after the attack,
(F) The future of the stay of a major western force in an Islamic country,
(G) The effects of the Iraqi operations on the terrorism, and
(H) The effects of the possible disintegration of Iraq, especially in the Kurdish area

5- Terrorism: terrorism affects the oil prices in two ways:

(A) Damaging the oil facilities and transportation routes, and
(B) Creation of instability in the concerned countries.

The first one is reflected in attacks of the Iraqi insurgents against the oil industry, and second one is reflected in the terrorist activities of the Chechen fighters against the Russian Federation.

It is noteworthy that the land of Chechens is an important route for transportation of the Caspian oil from the land locked countries of the region and Russia. The possible terrorism in the Baku-Jeyhan Pipeline (CPC) that is due to start its operation in 2005 is already subject of activities in the region including the preparations under the supervision of NATO, and with participation Turkey and Azerbaijan Republic. Terrorism in Saudi Arabia can be an important element on the oil prices, especially taking into consideration that the Saudi exports will reach its maximum level in near future. A major change in the Saudi oil flow will have extensive results on the oil prices.

6- The Middle East, the home to great sources of crude oil is in danger of turmoil from many sides including the Arab-Israeli conflict. Many countries may get disintegrated in the future due to the internal tribal and racial differences and reduction of the central controls due to the advancement of the technology and political complications. Any turmoil in the areas will directly affect the oil prices. Geopolitical uncertainties are sources of concern and a ready-made excuse for the rising oil prices. The US plans in the Middle East have made the area prone to many developments.

In addition to the basic elements, there are some temporary or periodical elements that affect the oil market in varying degrees. Some of the important ones are:

1- The crisis of Venezuela, which is basically a conflict between the government and oil companies.

2- Russian Federation's developments especially the arrest of Mikhail Khodorkosky, The CEO of Yukos Oil Company and one of the richest men in the world. There are concerns about the supply disruptions from the Russian Federation due to the problems of the Russian oil companies.

3- Nigerian political crisis, civil unrest, and border disputes that all related to oil.

4- The nuclear case of Iran (possibility of the Israel or US attack to Iran) is an element has should be watched. If for any reason the Iranian oil is cut from the oil market, including due to an American attack that disrupts the flow of the Iranian oil or an action by the Iranian government like setting fire to the oil fields (like Saddam's action in Kuwait) or blocking the Hormuz strait by sinking several tankers, the oil prices will shoot up to over 100 dollars per barrel. It should be noted that in case the oil prices reach over 70 dollars per barrel the global economy would be facing a general recession.

5- Any incident that makes the sensitive oil market volatile like the Hurricane Ivan that increased the process 3 to 4 percent, the US terror alerts, the changing of weather and getting closer to cold weather and rising demands.

When the oil prices are high, two major elements start to affect the process:

1- The inclination to exploit resources that were uneconomical with lower prices due to the cost of exploitation and transportations the markets, especially in the deeper seabed and more distant or deeper parts of the off-shore areas.

2- The more serious urge to find the alterative sources of energy and use of the already discovered ones such as wind, waves, geothermal energy, and the solar energy and of course nuclear power.

3- Other initiatives like: fuel-economy cars, energy efficient industries and better isolations to save energy.

However, the oil market will not be affected drastically by the above elements because:

1- The crude oil has potentials to be used in countless other ways.

2- The long presence of the cheap oil has hindered the search for alternative sources so seriously that it will take many years to change the trend.

Result: the oil prices are going to be around 50 dollars per barrel for a long time. In case a serious development happens like sharp cut in the supply side of the oil market due to the terrorism, military attacks, imposing of UN sanctions, or intentional acts, the prices are ready to go to the range of 80 to 100 dollars per barrel.

Bahman Aghai Diba, PhD Int. Law
Leesburg, VA - USA


Note:Bahman Aghai Diba, is the Senior Consultant to the World Resources Company in the Washington, D.C. area.



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