NEW YORK (Dow Jones)--For $100 oil, the third time was the charm.
The oil market chose the first trading session of 2008 as its stage for the final and successful run toward the milestone. Light, sweet crude oil for February delivery hit $100 a barrel on the New York Mercantile Exchange at around 12:10 p.m. EST. Recently, the front-month contract was at $99.50 a barrel, up $3.52 on the day.
Although the impact of events behind oil futures' rise on Wednesday have been augmented by funds flowing into the market, those events represent the broader concerns that have taken oil 64% higher since the beginning of 2007.
Oil futures rose on supply fears borne of attacks in oil-producing Nigeria, a weaker dollar and portfolio shifting by funds in the new year. Last week, amid low volumes, oil stayed surprisingly buoyant on news that Benazir Bhutto, the former Pakistani Prime Minister and opposition leader, was killed in a suicide attack. Falling U.S. crude-oil inventories, which have been on a six-week slide, are expected to post another decline in government data scheduled to be released Thursday.
Although investment banks like Lehman Brothers and Credit Suisse continue to predict oil prices in 2008 and beyond in the high double digits - forecasts that imply a retreat from current highs - the year-end rally came on a confluence of systemic factors that won't be easily resolved. Even if prices fall from $100, they won't fall very far.
Despite pointing to "obvious global economic uncertainties," Merrill Lynch on Dec. 13 raised its 2008 oil price forecast by $10 to $82, predicting that oil supply constraints, along with a "solid" demand picture would essentially offset rising macroeconomic concerns. The investment bank also increased its long-term oil price by $10 to $70.
"Biggest risk to 2008 forecast is a potential contagion to emerging markets from a decelerating U.S. economy," Merrill Lynch said in the report.
No Shock This Time
The last time oil prices were trading near these levels in real terms, the world was reeling from the overthrow of the Shah of Iran and the Iranian Revolution, as well as the start of the Iran-Iraq war and lingering fallout from the Arab oil embargo of the early 1970s. The price spikes these supply shocks caused were blamed for inflation, recessions and long lines at U.S. gasoline pumps.
This time, even though prices have risen tenfold from when they bottomed near $10 a barrel in 1998, there have been no major supply shocks to fuel the rally and so far, no major economies hurled into recession. Growth in the U.S. has decelerated in the second half of 2007, but economists attribute this primarily to falling house prices and tightening credit standards.
Extraordinary demand growth from Asia, mainly China and tightening global supplies have driven oil prices progressively higher throughout the decade. Supply blows have played a significant role, not least the Iraq war, which crimped that country's oil supply for years. But the main factors behind the huge increase in oil prices has been rising global demand, a gradual flattening in oil output and the potential for more supply problems.
"Previous oil spikes have been caused by a shock to supply, but you don't have that this time," said David Kirsch, who heads the market intelligence service at consultancy PFC Energy in Washington. "What you have is very strong demand that's pushing upstream capacity to its limit. As prices get higher, we're not seeing a decrease in demand, we're still seeing rapid development of the world economy fueling demand for oil."
Crude oil prices last reached an inflation-adjusted high of $102.81 in April 1980, according to monthly averages of cash prices provided by the St. Louis Federal Reserve. (Nymex crude futures didn't begin trading until March 1983).
World Economy Surviving Oil's Rally
Despite the continued grind higher, what's perhaps been most surprising about this oil rally is the extent to which the world has weathered it. Developing regions seem to be taking galloping oil prices in stride through a mixture of economic growth and subsidies. More industrialized nations aren't feeling the pinch as much as they would have 20 or 30 years ago, because they run their economic engines more oil-efficiently.
"The role of oil in OECD economies is diminishing, and is now concentrated in premium-use sectors, which are transportation and petrochemicals" rather than power generation and heating, said David Fyfe, senior oil market analyst at the Paris-based International Energy Agency, the energy watchdog for the Organization for Economic Cooperation and Development.
According to the IEA, the amount of oil OECD nations used to produce one dollar of real gross domestic product was halved between 1973 and 2002.
The weak dollar has also played a role in oil's climb and in the world's ability to adapt to high prices. Since early 1999, the dollar has slumped 21% against the euro. While this is by no means comparable to oil's nearly four-fold gains in the same period, it has meant many countries aren't feeling the same pain when it comes to forking out for crude oil.
The dollar fell to a five-week low against the yen Wednesday, helped by a U.S. manufacturing report that suggested activity contracted in December for the first time in 10 months. The greenback fell to a low of Y109.33, its lowest mark since Nov. 28. The greenback also declined against the euro, with the single currency pushing to a three-week high of $1.4751.
"The depreciation of the dollar has softened the impact of the oil price on other major consuming countries," analysts at the International Monetary Fund said in a Nov. 5 report.
In nominal terms, oil prices are up some tenfold from their 1990s intraday low $10.35 a barrel, reached in December 1998. As an investment, crude has far outperformed the Dow Jones Industrial Average and gold over all those periods. Copper, driven by a similar demand surge, has matched or beaten crude since 2005 but not over the longer term.
Amid Scarcity, Oil's Price Floor Rises
Analysts and industry experts caution that there are always unknowns with any long-term energy forecast, but many have become confident of the notion that there is now a higher long-term "floor" for oil prices. The major oil companies are making investment decisions based on whether projects make sense at $40-$50 per-barrel, as opposed to $20-per-barrel a few years ago, said Cambridge Energy Research Associates Chairman Daniel Yergin.
"Whatever the floor is, we're certainly in a new era as far as oil prices," Yergin said. "In the early part of the decade, we were looking backward to the
Asian financial crisis. Now we're looking forward" to a world marked by strong energy demand, increased political risk and rising operating costs - and complicated by a weaker U.S. dollar, and uncertainty about the U.S. economy," he said.
Weatherford International Ltd. (WFT) Chief Executive Bernard Duroc-Danner likens the world's global oil resource base to an athlete that has reached middle-age and requires more maintenance to perform. In terms of oil-industry dynamics, that means it costs more money to produce less oil.
"The underlying resource base is older, less able to grow and there isn't any spare capacity," Duroc-Danner said.
In terms of oil prices, this shift means $40-$50 per-barrel in the new era, as opposed to a range of $14-$22 in the previous one, Duroc-Danner said.
A price lower than $40 is possible, but not likely, he added.
There have been political factors in recent years that have depressed oil output also and which show no signs of abating. These include languishing oil production in Venezuela due to an overhaul of national oil company Petroleos de Venezuela ASA (PVZ.YY) under President Hugo Chavez, and the impact of the Iraq war, which depressed Iraqi output for years until this fall.
Without endorsing the notion of "peak oil," some leading oil companies have begun describing petroleum resources as increasingly constrained. These include ConocoPhillips (COP) and Chevron Corp. (CVX), whose chief executive, Dave O'Reilly, declared famously in 2004 that "the time when we could count on cheap oil and even cheaper natural gas is clearly ending."
There is precedent for a permanent upward shift in prices. Prior to the Arab oil embargo in October 1973, oil prices traded for just a couple of dollars per barrel, before immediately increasing fourfold.
The embargo came on the heels of a dramatic period of global economic growth that saw oil consumption jump from 21.3 million barrels a day in 1960 to 57.2 million in 1973, according to data from the U.S. Energy Information Administration. The Organization of Petroleum Exporting Countries was first formed in 1960, but didn't emerge as a meaningful influence on prices until after 1973. While oil prices have tumbled sharply a few times, especially in 1986 and 1998, they've never dropped to pre-1973 levels.
Analysts point to demand and supply factors as supporting another permanent shift in prices. The EIA currently estimates that China's oil demand will grow from 6.4 million barrels a day in 2000 to 10.5 million in 2015 to 15.7 million in 2030. While that increase could ebb for a variety of reasons - including a move by the Chinese government to scale back fuel subsidies -analysts liken the shift in Asia to the systemic increase in energy consumption by the OECD countries in the twentieth century.
Source: Matt Chambers, Dow Jones Newswires; 201-938-2062; matt.chambers@dowjones.com