Issue: 164
Sent: 09-06-2009 11:45:02
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Oil Prices: Facing the Pressures of HistoryEmail Marketing Business Opportunity - Helen BairstowWorking Longer - Part 3The Easiest way to do a Client NewsletterWhy Warren Buffett won't buy a NewspaperLower income earners: DIY financial advice
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Oil Prices: Facing the Pressures of History

Click here to buy - A How To Book of SMSF's by Tony Negline
John Robertson

OPEC wants crude oil prices to stay above US$70 per barrel. The rest of the world needs them as low as possible. The two remain on a collision course. Usually, the commodity producers lose.

OPEC Secretary General Abdallah El-Badri opined recently that nothing below $70 per barrel is a reasonable oil price. The Secretary General had two criteria for reasonableness: a price that would justify both upstream and downstream investment and a price that would give the producing countries an adequate income.

At $70 per barrel, crude oil prices would have risen by an average 9.0% a year since 1970, prior to the first oil shock. Over the same time, US consumer prices have risen by 4.5% a year and average disposable incomes in the USA have grown at a 7.2% annual rate. At least over this 40 years, crude oil prices have risen in real terms.

The continuing rise in oil prices runs contrary to what is needed to support rising living standards in most of the world. Human economic progress cannot be achieved unless the real price of basic commodities falls so that purchasing power is freed up for other expenditure including spending on leisure, recreational and discretionary activities.

Historically, raw material commodity prices have moved down. In more recent times, we have also seen a dramatic fall in computing prices as another illustration of how economic forces work to improve welfare.

Computer chips, for example, have become cheaper just as they have become more sophisticated and powerful. Despite the public squabbling in Australia between the government and Telstra, Australians now have access to faster internet speeds and greater broadband capacity at lower prices offering more opportunities for widespread productivity improvements, another illustration of how economic progress is made.

Similarly, falling real motor vehicle prices and lower airline travel costs have facilitated local and international mobility enhancing commercial opportunities and giving individuals unprecedented access to vacation and leisure opportunities which have spawned a growing global tourism industry.

The global oil industry has a set of geopolitical overlays that do not exist in other commodity or product markets and which are helping to stall some of these pressures. Saudi oil minister Ali al-Naimi recently bristled at OPEC being referred to as a cartel. "Cartels are gougers; Opec isn't", he insisted.

Whether or not OPEC has successfully affected prices, its intentions and objectives with respect to global oil prices are clear. OPEC members do try to keep prices rising fast enough to support income growth among its member countries.

At the same time, however, to sustain their own living standards, the advanced oil consuming economies require world prices to be rising more slowly than their incomes. There is an inevitable tension between these two aims.

After oil prices tripled in the late 1970s, demand for oil slumped by 10% and global economic growth declined from over 4½% in 1978 to under 1% in 1982. In the aftermath of the Lehman Brothers failure in 2008 and amidst the near demise of many other eminent financial institutions, attention was diverted from the damage done by a sixfold jump in oil prices in the prior seven years.

If oil prices rise again, they will again erode purchasing power among oil using economies. Central banks will again become fearful about inflation prompting them to keep interest rates higher than otherwise would be the case further eroding individual and business purchasing power.

To extricate themselves from this vicious circle, advanced oil consuming economies need to find, as quickly as possible, practical alternatives to petroleum, particularly as a fuel in motor vehicles.

In the past week, we were able to celebrate an important milestone in achieving this. For a long time, the US car industry was credited with preventing the emergence of alternative engine types as they sought to sustain their economic might. In this regard, some say, there was an unholy alliance between the car giants and the oil cartel. With Chrysler in bankruptcy protection and the once mighty General Motors going the same way, this impediment has lost its potency.

Eliminating the world's dependence on petrol powered internal combustion engines would be needed to underpin a long term decline in oil prices. Investment in additional capacity would not be needed allowing petrol prices to act like other commodity prices and, over time, decline.

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