Oil cartel Opec is starting to get a bit twitchy about the soaring oil price.
The Angolan oil minister, Jose Botelho de Vasconcelos, reckons that $75-$80 a barrel is the optimum level for both consumers and producers. We’ll come back to that view in a moment. But he’s also worried. If the price keeps rising towards $100 a barrel, Opec members might be open to pumping a bit “more oil into the market,” he says.
But why should Opec be worried by rising prices? And can they do anything about them?
Oil’s threatening to escape its ‘optimal’ price
The world is gradually succumbing to the notion that we’re back in Goldilocks territory. Economic policy is “not too hot and not too cold” – it’s “just right”. The one big blot on the horizon is the rocketing oil price.
Although it slipped back yesterday, oil has recently clawed its way above the $80 a barrel mark. That’s threatening to escape from its ‘optimum’ range of $75 to $80 a barrel, says Opec president, Jose Botelho de Vasconcelos. “I think a balanced price is always better.”
Now I can’t claim to have any idea where Opec gets this optimal ‘balanced price’ of $75-$80 a barrel from. I suspect that it simply comes down to what they think they can get away with. Bear in mind that at any point in history other than the past two years, an oil price at that sort of level would have been deemed an utter catastrophe for the global economy. After Hurricane Katrina, for example, the highest the oil price rose was to just over $70 a barrel.
So it’s quite impressive that oil producers have managed to ‘sell’ the idea of $70 plus for a barrel of oil as an aspirational target price, rather than a horrendously expensive level for the world’s key raw material.
Why Opec is concerned about the soaring oil price
But now even Opec is concerned. For one thing, once you get to this price, countries and independent producers have much greater incentive to seek both alternative energy sources, and alternative oil sources. Investment in these areas has been hit by the recession, but it’ll soon pick up again if it looks like $80 oil is here to stay. So by a ‘balanced’ oil price, Opec means one which generates lots of profit for them, but is still not sufficiently attractive to encourage serious investment in alternatives.
And of course, there’s the little matter of the global economy. One of my key personal economic barometers is the price at the petrol pump. When the price per litre dipped briefly below 90p earlier this year, I felt that little bit richer. Now that it’s pushing £1.10 again, I’m wondering where to cut back.
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As Neil Atkinson at KBC Services tells The Times, “if the oil price continues to rise in the next week or two, there is a danger that the economic recovery will be strangled at birth.” A fresh collapse in the global economy would of course hammer the oil price again.
So Opec wants to avoid killing the golden goose. High oil prices sow the seeds of their own destruction, and the oil cartel would ideally like to find the ‘Goldilocks’ level at which they can make handsome profits while allowing the global economy to stay afloat.
But can Opec increase production faster than the world’s central banks can increase the money supply? If oil prices are being driven higher by the same thing pushing up every other asset class – cheap and free-flowing money – then Opec’s efforts to fiddle with supply and demand will have little impact on the price.
This is a serious threat to the current ‘recovery’. Andy Xie argues in the South China Morning Post that high oil prices in 2006 were the “final straw that tipped the US property market” – US consumers squeezed by rising petrol (gas) prices finally succumbed to the weight of their unaffordable debts. He also argues that the resurgence of oil in 2008 “pulled the rug out from under the derivatives bubble.”
An oil bubble, he says, is different from others. It hurts consumption, and it also drives inflation higher, which eventually results in tighter monetary conditions. “Oil speculation is the party crasher, even though it destroys itself by destroying others.”
How to protect your portfolio from the oil price rise
He reckons that there’s a good chance that we’ll see $100 oil again sooner rather than later. But that will almost certainly mean a “double-dip” recession in 2010, as once fiscal stimulus is pulled out of the economy, consumers are unlikely to pick up the slack, due to high levels of unemployment. John Mauldin of Investors Insight agrees – he also “firmly believes” that we’re heading for a double-dip recession in the next 18 months. And during a recession, he points out, share prices fall by an average of 40% – so “adjust your portfolios accordingly,” he advises.
We’ve been advising readers to stick with defensive stocks during the rally, and we wouldn’t be in a hurry to sell them – you’ve probably locked in some attractive dividend yields, and if not, a few stocks still have decent-looking yields (see my colleague David Stevenson’s recent piece on the pharma sector, for examples: Snap up drug stocks while they’re still cheap.)
But with respected economist Andrew Smithers for example, reckoning that the S&P 500 looks about 40% overvalued right now, we wouldn’t be keen to invest in a tracker any time soon. And if you are sitting on decent profits from more speculative stocks, it might be worth locking in at least some of those gains if you haven’t already.
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