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CIEP Energy Paper
The Hague, Clingendael Institute, July 2008,
108 pp.
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Oil turbulence in the next decade, Jan-Hein Jesse and Coby van der Linde
A CIEP analysis of the recent development of demand and supply for crude oil indicates that the mismatch in supply and demand growth could cause tighter oil markets than we already experience today. In the World Energy Outlook 2007, the International Energy Agency (IEA) warned of a possible 'energy crunch'. But what was anticipated to happen in the first part of the next decade has been fast-forwarded to today, more than 5 years earlier, and could shake the very foundation of our energy systems if no action is undertaken. Without exaggeration, the recent developments in the international oil market are ground-breaking: a little over a year ago, in January 2007, the West Texas Intermediate crude oil price (WTI) traded for $50 dollar a barrel. Within a year, the price doubled to $100 per barrel in January 2008 and pushed through to over $135 in June 2008, against the backdrop of the fresh market supposition about reaching a whopping $200 per barrel in 2009. If this proves to be true, the world will not only have moved from an "Oil Demand-led World" to an "Oil Supply-constrained World" (since 2004) but, more importantly, will then also experience a radical change in the oil price formation.
Until recently, the oil price was largely underpinned by the marginal cost of the last barrel needed to match demand, with some political and economic conjuncture mark-ups or -downs. As will be presented in this paper, the current high oil prices are still primarily driven by structural factors that can be well explained without resorting to blaming speculative investors playing the futures market or the low dollar. But if prices are heading towards $200 a barrel in 12 months' time, or for that matter even to $150 a barrel, other drivers will gain prominence over marginal costs as the main driver. In that case, OPEC will have accomplished a long-held wish: oil will then be priced at its real value in the Western world (for instance the economic value of mobility for consumers, or the value of plastic components or cargo transportation). Such a new price regime, pricing at the "User Value", also implies that the oil price will not necessarily invite new supply into the market, since income requirements of producing countries (especially OPEC member states and Russia) will be easily met through price rather than volume. In such a world the current economic logic that crude oil prices tend towards the marginal cost of supply will no longer hold true. Oil will no longer perform as a commodity but will instead be priced for its economic and strategic value, with the User Value of oil further divorcing cost from price.
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For more information please contact Coby van der Linde
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