The Economist Asia - 20.01.2018

The EconomistJanuary 20th 2018 59

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1

P

ERHAPS the most vexing thing for those

watchingthe oil industry isnot the

whipsawing price of a barrel. It is the con-

stant updating oftheories to explain what

lies behind it. In March 2014, when the

price of a barrel of Brent crude was in three

figures, the then boss of Chevron, an oil

giant, observed that the scarcity of cheap

oil meant “$100 per barrel is becoming the

new $20”. Two yearslater, when the oil

price slumped below $28, the talk was of a

global oil glut caused by the furious efforts

of the OPECcartel to regain market share.

Now that oil prices have tested $70, an-

alysts are again scratching their heads.

In “1984”, George Orwell coined the

term “doublethink”, the ability to believe

two contradictory things. Oil analysis

seems to require similar cognitive gymnas-

tics. Three big questions arise. First, why

has the oil price more than doubled in the

space of two years, against all expectation?

Second, why has this surge been met with

cheers from global stockmarkets and not

concern for the world economy? Lastly,

where might the oil price eventually settle?

Start with the journey to $70. The

slump in prices two years ago was in part a

response to weak demand—with the fragil-

ity of China’s economy a big concern—and

in part to abundant supply. Few believed

then thatOPECwould, or even could, cut

output. Saudi Arabia, the world’s largest

oil exporter, appeared to have every rea-

son not to. Plentiful oil supply would check

It is still surprising they have risen so far.

Higher prices are often blamed in part on

the messy politics of the Middle East. The

usual worries are there but “there has been

no impact on physical supply,” says Mar-

tijn Rats of Morgan Stanley. Shale was also

seen as the oil industry’s flexible response

to price signals. Too high, and the wildcat-

ters in Texas would drill for fresh supply.

But small producers are showing a new re-

straint, because their financiers want great-

er focus on profits and less on output. And

it takes several months from drilling wells

for oil to come on-stream.

The financial markets show little sign of

anxiety about the oil-price surge. Stock-

markets remain buoyant, which is itself

anotherpuzzle. Since the oil shocks of the

1970s, markets have associated a sudden

run-up in oil prices with economic calami-

ty. The world is both producer and con-

sumer of oil, so in principle the overall ef-

fect of oil-price increases is neutral. But in

practice, the net impact had been to reduce

global demand, because oil exporters in

the Middle East tended to save a big chunk

of the windfall income they gained at the

the growth of the shale-oil industryin

North America. It would also stymie Iran,

its bitter rival, which was back in the mar-

ket following the lifting of sanctions.

Yet demand recovered quickly. China

pepped up its economy with faster credit

growth and other fillips to spending. Com-

modity prices surged. Within months clear

signs of a broad-based global economic

upswing were palpable. And OPECproved

better able to curb production than anyone

had imagined. A deal reached in Novem-

ber 2016 to restrict output had little imme-

diate effect but by late last year started to

pay off. Oil stocks fell, notably in America

(see left-hand chart). Demand was out-

stripping supply. Prices duly rose.

The oil price

Crude thinking

High oil prices are mostly a reflection of a healthy global economy, not a threat to it

Finance and economics

Also in this section

60 Buttonwood: Hedge funds

61 Downward digital currencies

62 The Big Mac index

62 A wobble at the World Bank

63 State venture-capital in France

64 Free exchange: Driverless cars and

congestion

Stocks and shares

Sources: IMF; EIA

Crude oil

United States, stocks, barrels, bn External breakeven price, 2016, $ per barrel

0 20406080100

Kazakhstan

Libya

Algeria

Oman

Saudi Arabia

Qatar

Kuwait

Iraq

UAE

2009 11 13 15 18 Iran

0.95

1.00

1.05

1.10

1.15

1.20

1.25