Even as the price of crude oil rocketed to record highs this week, OPEC's Secretary-General Abdalla Salem El-Badri argued that non-market factors were responsible for the rising price of crude. "The turmoil in some global equity markets and the considerable depreciation in the US dollar have encouraged investors to seek better returns in commodities, particularly in the crude oil futures market. This has driven prices higher," he declared.

He also suggested that the world continues to enjoy an adequate supply of oil. "There is clearly no shortage of oil in the market," he asserted. "OECD commercial oil stocks remain above the five-year average, with days of forward cover at a comfortable level of more than 53 days." The reference to oil inventories hinted that OPEC might be placing greater weight on oil stocks than the price of crude oil in reaching its assessments. It should be noted that strategic petroleum reserves are not counted in the oil inventories figure OPEC cited (which was published by the International Energy Agency).

If that is the case, it raises an interesting issue: does OPEC want to place a ceiling on and perhaps even seek a reduction in industry stocks? If so, economic activity could become more vulnerable to oil supply disruptions, one could expect a higher risk premium in the oil markets, and oil price volatility could increase. At the same time, OPEC's bargaining leverage would also be enhanced.

In a larger geopolitical framework, the reality that OECD nations have higher oil stocks than many of their developing peers suggests that an OPEC policy that possibly increasingly targets oil inventories could inflict disproportionate pain on developing countries. Given that developing countries are, on average, more energy intensive than developed ones (consume a higher amount of oil per $ of GDP), such a policy could add pressure on those who have high foreign reserves to try to lock up oil supplies for their own markets. China has already had some success in reaching an agreement toward that end with Qatar with respect to liquid natural gas.

Energy nationalism would lead to greater geopolitical risk. First, national considerations would trump market needs in the allocation of oil production (both in the policies of the suppliers that have nationalized oil production and consumers who seek exclusive deals). Second, the Third World states with the least financial resources and lowest inventories could be crowded off the path of economic development resulting in lower living standards and a greater incidence of poverty than would otherwise have been the case. Third, as states jockey for access to oil supplies, they could be tempted to play off ethnic groups against one another in select multiethnic oil producing states e.g., Nigeria, among others, in a bid to gain access or overturn another state's access to such oil. Given that a number of oil producing states experience a combination of past ethnic/tribal/sectarian conflict, poorly performing governments, and rampant corruption, the risk of conflict in such states could increase.

To date, efforts at locking up exclusive access to energy supplies has been limited. The question remains whether that would remain the case 10-20 years down the road, especially if a demand imbalance holds, backwardation is sustained by OPEC policies to the point of reducing oil inventories, and nations begin to confront energy-related tradeoffs.

In my opinion, it will be important to strengthen the WTO process to assure open access to the world's energy supplies, much as international law currently allows open access of the world's sea lanes. Comprehensive and robust energy policies will also be useful in helping nations increase their own domestic production of oil (where possible) and to develop alternatives that expand their range of energy options so as to preclude the development of destructive zero-sum competition for energy access.

Although it is true that some of the oil futures contracts have been purchased by institutional investors (pension funds, insurance companies, etc.), some of the major reasons cited for such purchases have to deal with hedging for inflation and also a declining dollar. I do not believe it would be productive to try to bar investors from purchasing contracts, shares, or other financial instruments.

In my opinion, a better starting point would be for policymakers to begin to address the imbalances responsible for the hedging. In this case, that would entail tackling the issue of the declining dollar (which would require continuing to allow the trade imbalance to unwind and meaningful reductions in the federal deficit) and addressing inflation (a decisive statement that the Fed will be turning its focus to inflation and, if inflation fails to abate in the months leading to the June FOMC meeting, an interest rate hike of 25 basis points to demonstrate credibility on that front). The Treasury could also coordinate with the EU to make a firm statement that the U.S. wants the dollar to increase in value and that, if necessary, would engage in a coordinated intervention to stabilize the dollar. If necessary, it would need to back that statement with visible action.

With respect to longer-term oil market fundamentals, federal policymakers should develop the energy policy that they have failed to do so even after the experiences of the 1973 and 1979 energy crunches. The chronic neglect to do so has been bipartisan. A credible energy policy would include supply-side remedies e.g., incentives to increase domestic crude oil production and exploration, along with demand-side ones e.g., encouraging greater conservation via tax, fiscal, and regulatory policy tools. It should also provide a robust investment component to help finance aggressive R&D into longer-term alternatives and more immediate ones e.g., nuclear power.

Given the nation's fiscal situation, such funding could be obtained through specific cuts elsewhere in the budget or through an across-the-board cut in all discretionary programs. Energy policy is a vital national security and economic issue.

The bipartisan chronic neglect to develop such a policy has, in part, contributed to today's situation in leaving the U.S. in a less flexible position to deal with the fundamental realities that drive the energy markets. Political gimmicks, be they temporary gas tax holidays or imposition of the windfall profits tax, both of which would inflict harm (the former would increase demand for gasoline while the latter would decrease production-enhancing investments) should be avoided.

Originally Posted by jb_1430 "No shortage"????? Thats because oil is selling at $126 a barrel...or whatever. bring it back down to $60 a barrel and the shortage would be more apparent.

Originally Posted by Doc Howl Why? People aren't using any less oil than they were when it was cheaper.

Originally Posted by Doc Howl Why? People aren't using any less oil than they were when it was cheaper.

Last month, following OPEC Secretary-General Abdalla Salem El-Badri's reference to oil inventories in arguing that the world oil market is well supplied, I noted that those remarks hinted that OPEC might be placing greater weight on oil stocks than the price of crude oil in reaching its assessments.

Yesterday, some of the international media quoted OPEC President Chakib Khelil as indicating that OPEC no longer would be setting production to meet price bands. In other words, OPEC's production is no longer focused on maintaining price stability within a price range. Other factors will weigh more heavily in OPEC's decisionmaking e.g., oil stocks.

Xinhua quoted OPEC President Chakib Khelil as follows:

Producing and consuming nations never agree on any price. You remember we talked about 15 (U.S.) dollars and they were saying 13 dollars. We talked about 22 dollars and they were saying 18 dollars. Then we put a price band of 22-30 dollars, but they never agreed with the price band... Then we did away with the price band. Now they say we need to come back to the price band, but we are never going to agree. Let the oil market decide the price...

Given OPEC's position that the oil market should determine the price of oil, should evidence of demand reduction increase ahead of OPEC's September meeting, it is not implausible that OPEC could maintain current production levels or, if oil inventories are increasing, give consideration to a reduction in production. A decision toward the latter scenario still appears to be less likely right now, but it might be discussed at the meeting. If so, OPEC would be creating a framework in which oil prices tend to be sticky on the upside and have only modest downside potential e.g., prospects for a price under $100 per barrel would be low, at least through the remainder of this year.

Finally, Mr. Khelil's rejection of a restoration of oil price bands likely assures a greater level of uncertainty in the oil market. A price band creates an anchor for expectations. The absence of a band leaves no anchor.