Al-Ahram Weekly On-line 21 - 27 September 2000 Issue No. 500
Published in Cairo by AL-AHRAM established in 1875

	Egypt Elections Development Region International Economy Opinion Culture Features Special Travel Living Sports Profile People Time Out Chronicles Cartoons Letters

Oil price dilemma

By Ibrahim Nawwar

OPEC's decision to increase oil supplies by one million barrels a day has failed to halt the upward spiral in prices which, at $37 a barrel, are now close to the all time high reached during the Iraqi invasion of Kuwait in 1990.

But while dealers are once again keen to blame Iraqi belligerence for recent price rises, this time round their arguments are less than convincing given the power the dealers have themselves accrued, over the past decade, to determine the price of crude. For no matter how much oil is pumped today, regardless of how much is consumed, its price will have been determined by traders operating in the futures market. In short, it is the futures market that sets spot prices.

And in recent week's the dealers have been aided by two additional factors. First is the seasonal factor: the approach of winter has traditionally seen increased market volatility as the oil refineries' demand for crude grows. For two months now the refineries have been waiting for prices to fall before securing their winter stocks. But prices have continued to rise, placing the refineries in a double bind. Winter is now around the corner, and there is no indication at all that prices are about to take a tumble.

Second, though OPEC has decided to increase production from the beginning of October, it will be four weeks before those additional supplies reach the market. In fact OPEC is itself contributing to the increase in oil prices through the rigid price mechanism it adopted in June, according to which the organisation will only intervene after three weeks of price fluctuations outside an agreed band. The June decision came as a godsend to traders, who are guaranteed a virtually risk free 20 day period in which to speculate. The 20 day period is easily long enough to buy and sell contracts and then settle accounts, given that the settlement period for oil contracts usually ranges between three and fourteen days.

Events of the past few weeks, though, should not obscure the fact that recently a reasonable balancing act has been maintained between supply and demand. Demand has been rising since the beginning of the year, but so too have supplies.

FUELLING PROTESTS: As oil prices continued to rise despite an OPEC decision to increase production, protests have spread from Britain, left, where they began, to afflict not just Europe -- on Tuesday Seville, in Spain, was blockaded by angry farmers driving tractors -- but the far East, some African states and, closer to home, Israel photos: Reuters

The real dilemma OPEC is now facing is that any significant increase in supplies could precipitate a crumbling of the market similar to that which occurred two years ago, when oversupply resulted in a market glut, pushing prices down to almost $10 a barrel. It is a scenario that could easily be repeated if supplies are boosted now, for as soon as the refineries have acquired enough oil to fill their storage facilities, prices are likely to face a free fall from their current levels to less than $10 a barrel.

If OPEC is seeking to play an active role in bringing balance to a nervous market it is imperative that the organisation adopt another price mechanism, one that is more flexible than that agreed in June, and capable of limiting the influence of the speculative traders.

The simplest formula would be for OPEC to maintain a floating oil reserve (FOR) of about half a million barrels a day which, when necessary, it could release onto the market in order to secure a higher level of stability. This FOR should be managed and financed by OPEC as a whole, and would furnish a reserve from which it could sell when prices are high, and a repository in which crude could be stored when prices are low. OPEC would then be able to adjust production levels according to movements in the FOR.

Such a mechanism would have the advantage of allowing any necessary increase in supplies to reach the market within days rather than weeks, and in doing so would effectively curtail the three week golden period of speculation dealers enjoy under the existing arrangement. Indeed, speculative trading would almost certainly disappear, given that oil supplies would reach the market, and impact on prices, before the settlement date of contracts.

Put simply, market traders are there to make money, and they will continue to do so at the expense of consumers as long as they are able. The West, too, has an alarming propensity to blame OPEC for any increases in petroleum prices, when up to 80 per cent of the cost passed on to consumers is actually accounted for by the duties levied by Western governments, the self-same governments that up until now have been all to happy to ignore the fact that oil prices are controlled by speculators operating in major markets like IPE and NYMEX. (see region)

	weeklyweb@ahram.org.eg