It Doesn’t Take Much to Rattle the Oil Market

The price of oil fell almost $2 a barrel last Monday as commodity traders started to breathe easy. It settled at $61 dollars after briefly dipping to $60.85. Traders were relieved that an al Qaeda attack on some Saudi oil facilities was foiled.

For some of you this must seem strange. How does a botched al Qaeda attack send the price of oil down $2? Well it gets stranger than that. Why does a civil insurrection in Nigeria do the same thing in reverse? Why is the price of oil important to ordinary Canadians?

Aside from the ridiculous “conspiracy theories” you’ll hear from the more paranoid among us, it all has to do with risk. Risk is the currency which drives almost any financial market. Whether it is currency, oil, orange juice, soybeans, corn, or any other commodity their price is determined by how traders measure risk. If the risk to the market is deemed high, the market goes up. If the risk to the marked is deemed low, prices retreat. This is an aside from the usual supply and demand components of any market.

So when two cars carrying a bunch of crazy bombers attempted to go through the gate at the Abqaig oil plant near Damam, Saudi Arabia last week, traders got nervous that a lot of oil would go up in smoke. These guys were shot down by Saudi security. When the dust cleared, oil was still flowing. It took a day or two, but when the coast was seemingly clear, oil traders thought the risk was too. Oil dropped $2/barrel.

It might drop further except for the civil unrest in Nigeria. 30% of Nigeria’s oil output has been cut. There has been escalating violence between the Nigerian military and the Ijawa and Itsekiri tribes. Many people have been hurt and killed. The oil wealth is the issue. Oil facilities have been threatened with sabotage.

What’s this mean to the world oil market. You guessed it, increased risk. That’s one reason why futures markets are staying where they are. Put that Nigerian production back on the world stage and wouldn’t oil be heading down to $55/barrel?

I don’t know. Clues might be found in the monthly futures chart for oil. For the period between 1993 and 1999 oil traded between $12/barrel and $25/barrel. However in January of 2002 oil was trading just under $20/barrel. Earlier in 2005 it briefly went over $70/barrel. Now we are at $61/barrel. So in the last four years we have seen oil go up at least $40/barrel, while between 1993 and 1999 it really didn’t change. So what’s up with that? Has the world demand for oil fundamentally changed?

Some economists would say “yep” to that question. Remember that little ditty called India and China? With economic growth rates of 5-10% over a period of years, their demand for oil is rising rapidly. Oil prices have responded accordingly. Some of us might not like it, but the days of $20/barrel oil are probably over. You’d better hope for some new technology to save the day, like hybrid cars.

It’s not like we aren’t trying. North American agriculture has fostered ethanol as a fuel additive, which will cut oil demand. There is a burgeoning green movement. However, energy consumption is still very high in the west. How can we chafe at energy prices when our eastern cousins in Indian and China are taking their rightful place in the world economy?

What you say? It’s easy isn’t it? Yes, we complain anyway. We’ve grown used to cheap energy in this part of the world and many of us can’t quite get around on gas at 90 cents/litre. North Americans insist on driving big, expensive, heavy gas-guzzlers. The oil companies are laughing all the way to the bank.

Some of you might say, “with Alberta having oil to no end” why do we have to pay so much? Why? Why? Why? It all has to do with the free market our energy trades in. Add in the NAFTA agreement and you’ll realize this will never change. There will be no “National Energy Program” and no regulation of oil prices. It might be
different for consumers in Venezuela and Kuwait. Those countries have national regulated policies to keep domestic energy cheap. We went there once in Canada. It’ll never happen again.

The answer or course is to fight back by reducing your oil consumption. Wear a sweater in the house, swim in a cold pool, drive a small fuel-efficient car, walk that two blocks. So when some crazy in Saudi Arabia attacks a refinery or when civil unrest rattles the oil market, it won’t have the same effect on you. Getting there is the challenge. The problem is that person in the mirror.