This year's oil price advance is different from last year's. During the summer and autumn 2004, the price of oil was increasing but the dollar was falling against the euro. Now, the price of oil is again advancing and so is the dollar. For us in Europe, therefore, the squeeze is more painful, comparatively speaking, than for the Americans.
There is another aspect too: as the price of oil increases, more dollars are required to buy one barrel and, although an increasing price somewhat dampens consumption in the short-term, the price of oil increases the demand for dollars. This works in favour of the dollar and against the euro.
The price of oil has a glass ceiling. Oil fuels the world economy and as its price increases, growth slows, and inflation rises. The IMF had calculated that a $5 per barrel increase reduced global growth by 0.2 per cent in the first year.
In recent years, western governments have steadily pumped oceans of money into their economy in order to avert a deflation, and they have succeeded, so far, albeit by the skin of their teeth. This money is sloshing around creating bubbles here and there and pushing up asset prices, many of which don't get caught in conventional inflation measures, at least not immediately.
The way money has been pumped into economies makes investment today seem like hopping from one bubble to the next.
Resources, especially energy and metals, are in heavy demand due to the rapid expansion of the Chinese and Indian economies. The US economy, considering its size and maturity, is doing well too. The US is the largest consumer of oil, using one-fourth of the oil produced, followed by China.
China and India are indeed producing some very impressive economic statistics. It does not mean that all the projections one reads about China and India are going to come true. The main challenge in China is whether central political control can withstand a rapidly expanding, increasingly complex economy which itself fuels the population's democratic aspirations. The question is there but the positive way the politics is evolving is very encouraging and the economy there is aflame.
Regretfully, I am not as positive about India, notwithstanding its great potential. The infrastructure seems lacking, the culture somewhat anti-capitalist, things take a long time, different rulers and governments over recent centuries have somewhat injected a great people with a sense of fatalism, the public sector has a heavy hand.
Often, it is people's attitudes and the way a country is organised, including respect for property and human rights (in its wider sense), that determines whether a country develops or not. For example, whoever thinks that Africa is going to develop and eliminate poverty by having its debt written off must be living in a different world. The countries in Africa which are actually progressing are doing so under inspired leadership and irrespective of the debt. Wiping off debt would give many corrupt heads of state and their cronies a fresh slate on which to borrow again, spend again and steal again.
The pressure on oil, and other resources, is likely to remain, but it may not be as high as some speculators are assuming. Apart from the possibility of a less-than-expected Chinese/Indian demand for oil, for the last 10 years, both Opec and non-Opec countries have been increasing production steadily.
It is refining capacity which is suffering from a bottleneck and pushing up prices; in the last thirty years or so, there's been a lack of new investment in refining plant. In fact, excess capacity fell sharply in late 2002 and early 2003, resulting in the oil price increases witnessed in 2004.
However, Opec has recently stated that it might not be able to produce enough oil to fill the projected increase in demand and this means that production must increase from all sources.
Japan and the US are also putting a lot of effort in developing alternative energy sources and reducing the dependence on oil, for example by developing hybrid cars.
The latest price increase past $60 per barrel has variously been put at the door of potential troubles with Iran, Tropical Storm Cindy and Hurricane Dennis, which are disrupting transportation.
As with any commodity, one has to try and distinguish between three sets of demand and supply sources. First, the actual demand and supply for consumption. For petrol, for example, this reaches a peak during the driving months of June to October and for heating oil and diesel the peak is in the winter months. Then there is stockpiling by governments and companies, creating demand as stocks are built up and releasing supply as they are run down.
Finally, there are speculators who try to anticipate consumption and stock levels, and the actions of other speculators, and take positions in the market to try and profit from these price movements, in the process often smoothening out price fluctuations by taking the brunt of market imbalances.
As I write, we are witnessing the horrific killing of the innocents in London and this will certainly not help sentiment.
Market View will return in September. pva@onvol.net
Paul V. Azzopardi is managing director of Azzopardi Investment Management Limited (www.azzopardi.com) which is licensed by the MFSA to provide investment services, including stockbroking. Mr Azzopardi or related parties, including the company, and their clients, have an interest in securities mentioned.
This article is only meant to provide information, which the writer believes to be accurate at the time of writing, and is not intended to give investment advice and its contents should not be construed as such. The value of securities, and the currencies in which they are denominated, may go down as well as up. Readers are requested to seek professional financial advice tailored to their own personal circumstances.