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The Oil Crisis - Good for Gold, bad for Global Confidence!

Julian D.W. Phillips

July 7, 2006

Now we see record highs for the oil price, but nothing is new in the oil market, and we canít really blame bombs in Bagdad or missiles in Korea. These are passing stories, even if they are disturbing to all. No, there has to be far more than this to take prices up this way. The reason is far more disturbing than a news item: -


China's aggressive hike of retail oil prices last week, the largest ever one-off increase, reflects Beijing's confidence its the strong economy and the need to let the oil flow into the country freely. It is very clear now that they believe that high global oil prices will not fall significantly.

Such a price increase after holding down prices [bear in mind that the government gives huge subsidies to the Industry] appears to signal growth will continue without the fetters on the oil industry. That has to translate into rising oil demand again, higher than at present inside China. Letís get perspective here again, because such a piece of news is in itself vague and difficult to measure. When we do gauge it properly, we can see this Ďbullí market in oil is here to stay for one or more decades, in which time the world had better have weaned itself off oil or see the world in a major fight over the remianing supplies!

China currently imports 500 million tonnes of oil a year, translating into around 10 million barrles a day. This has been restrained for nearly a year by the policy of the government of holding oil prices down. This led the refineries to export the oil it refined, because they could not afford to sell it locally. The price increase signals a change in this picture, allowing the oil into China and a pull-back on oil exports. Local demand has to jump on this, as growth continues, irrespective of the higher prices.

Demand from China alone is projected to rise to 2000 million tonnes by 2020, 14 years time. This equate to around 40 million barrels a day [It is difficult to be exact because there is a 12.8% variation in the weight of oil between the different types]. Now add just a doubling of Indiaís oil requirement from similar current demand levels, over the same period [despite the fact that India is growing at around 8% per annum] and you get demand rising to an increased daily demand of 50 million barrels a day.

This equates to 15 years of demand rising at 10% per annum from these sources. That is closer to 2 million barrelas a day, than one as a feature of the oil market for 15 years. This per day barrel number will increase each year up to over 4 million barrels a day in the final years of the period.

This forecast demand rise is not met on the supply front, where at present there is supposed to be a surplus of 1.8 million barrels a day, which must be diminishing as demand from these sources rises to meet it within one, or slightly more years.

There is new investment taking place (at least 11million barrels per day of new global refinery capacity by 2010, most of it located in Asia), as we mentioned previously. But on these figures that demand will be taken off as it arrives, leaving the globe in the same position then as now or with a supply shortage before it arrives and one after it arrives!

Oh, sorry we have not taken into account that supply from old fields, such as the North Sea, Cantrell in Mexico and those of Saudi Arabia is rapidly running out already, so take that supply out of the equation. Will China build it planned strategic oil reserves? If so add that demand to these figures. Now throw in the Joker, the weather?

This is a fundamental picture, which explains why oil remains over $75 a barrel, why it wonít fall to $50 and why any supply rupture will send the oil price up to $100.

Will these prices prove deflationary or inflationary? Unless allowed to spawn inflation, growth will be the victim. Do not be surprised if the Fed quickly abandons its fight against inflation, so as to lower the real price of oil and keep the economy healthy.

Julian D.W. Phillips

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