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USD1,000 a barrel oil: talking up fuel prices

20-Jun-2008
  • Oil price predictions usually based on fragile foundations;
  • US ATA seeking Congressional action to bring down oil prices;
  • Unclear how much of the inflated price is speculation;
  • China reduces fuel subsidy by 20%;
  • But blunt “silver bullet” solutions can be dangerous;
  • One exception: increase US taxes on gasoline to global levels, so drivers take to the air.

“Why not $1,000. It’s a nice round number...I say this with absolutely as much information at hand as the pinstriped sages who are making headlines with their soggy $200 predictions…Nobody knows what’s going to happen. So my goal here is to not know what’s going to happen at an even more dramatic level.” - Stanley Bing, Fortune magazine, 19-Jun-08.

This week, the US Air Transport Association made a passionate plea to Congress for help in the face of USD130+ oil. Now that US domestic petrol prices have risen to USD1 per litre (a price most of the rest of the world would die for), the US Congress is looking for a way out. The ATA plea had ominous rings of post-9/11 support requests, but presumably common sense will prevail on that score; this time around, the thought of propping up unsustainable airlines is not on the radar.

However, the ATA made some interesting observations, one of which, impliedly being that if enough people make a noise, any “artificial” price inflation should start to deflate.

Clearly there are several factors at work, above and beyond pure supply-demand forces. As a commodity, oil is now an investment target. Whether the resulting price increases, as investor and pension fund monies flow into oil futures, are the result of speculation or merely sound investing is a nicety.

But it is clear that talking up the price has an effect on real levels. Creating expectations generally leads towards their fulfilment.

The ATA’s submission for example observed specifically that, on 06-Jun-08, there was a spike in the number of oil futures contracts taken out. On that day alone, contracts equivalent to 22 times the total global usage of oil were concluded.


Sources: ATA, Citi Futures Perspective and IEA, from New York Mercantile Exchange (NYMEX) and London Intercontinental Exchange (ICE)

This is either a push-force, or simply a response from responsible investors fearful of further rises. Or both of those, plus speculation.

So, yesterday, when China – apparently at least partly in response to international pressures – reduced its domestic fuel price subsidy by 20%, any resulting reduction in demand should reduce global pressures, therefore creating a downward force on prices. It should, if demand-push is actually responsible for the price spike.

It could also slow China’s economy, which would negatively influence a whole region. Then again, it could help ease the worrying inflation that is starting to threaten China’s policymakers. Then again, it might not do anything.

Whatever the causes of the current fuel price levels, stabilisation will generally occur over time. Meanwhile, though it is perhaps fruitful to make loud noises about speculators, in the hope that will dampen excesses, using blunt “silver bullets” is not helpful, other than to make politicians feel good.

And, in the airline industry, how many CEOs, in their heart of hearts do not believe that the present spike could actually have a valuable cathartic impact on an industry desperately in need of overhaul?

And, in the US, there is actually a very simple way for Congress to help the airlines – even perhaps a silver bullet: increase petrol/gasoline taxes, so consumers pay the same levels as most of Asia Pacific does. That will reduce consumption - and all those drivers will fly instead of getting into their cars. Problem solved.


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