This oil price surge is no bubble

23 June 2008

Predictions of an imminent crash have fallen flat as oil prices continue to set new records. Except for a significant breakthrough that can change the long-term demand-supply scenario dramatically, nothing can burst this oil bubble. Because this is no bubble, this is for real! By Shivshankar Verma

Big oil producers and consumers just finished their weekend deliberations at Jeddah, Saudi Arabia. The conclave's agenda - discuss ways to ease oil prices - was quite serious and of pressing importance for the global economy. Most major oil consumers were represented and India sent finance minister P Chidambaram to voice its concerns.

The meeting, which was officially called the Jeddah Energy Summit, might appear a bit quixotic to most. Here is a meeting to talk about how to bring down oil prices, organised by the biggest oil exporter who benefits the most from higher prices. The organiser is also the chief promoter and most powerful member of a price cartel, whose other members were also present at the summit, and whose primary goal is to keep oil prices high. Despite these obvious conflicts of interest, they all promised to seek and find ways to ease the burden of high oil prices. The Saudi king, who presided over the meeting, even called for a global 'energy-for-the-poor' initiative – whatever that means.

In the end, nothing significant came out of the meeting. Saudi Arabia said it is ready to increase production for the rest of the year while other OPEC members were non-committal on higher output. Delegates from consuming countries went home after a pleasant weekend at the Red Sea resort city. It must have been a welcome relief for those like Chidambaram who have been facing intense political heat over rising inflation.

But, when the oil futures market opens for trading today, discussions at the conclave will barely register on prices.

This is about the very long term
The current oil price surge is not about short- or medium-term supply-demand dynamics. This rally is based on a fundamental long-term fact – the world will run out of oil one day and we don't have any viable alternatives, not yet.

In recent years, the demand for oil has proved to be much more inelastic than earlier thought – demand doesn't respond much to higher prices. There are many reasons for this, like the over-reliance on private transport in major consuming countries and the replication of this model in big emerging countries like India and China. Higher income and aspiration levels in these countries have also contributed, by pushing up the threshold of affordability. Hence, it is safe to argue that there will not be any appreciable decline in oil demand even if prices were to stay at these levels.