Thursday, March 06, 2008

Where will oil go?

Over the past couple of weeks the media has in large part ignored the most important threat to Jamaica today for a soap opera type event. The most important threat of course being the price of oil and the soap opera event the arrest of Kern Spencer. As far as I am concerned the arrest and charge of Kern Spencer, and his colleagues, should merely be mentioned and left to the court to determine their innocence or guilt, which is really of no consequence to mention repeatedly in the form that it is being continuously carried.

To be fair though the media is just reflecting news that they think will sell and the deep interest in this is really a reflection of Jamaicans desire for gossip instead of the real challenges that face us. Even in the reporting of the “soap opera” we have ignored the substantive points for the more superficial news, while seeming to forget that the real lesson from this is the need for accountability of politicians and the public sector rather than presuming guilt in a system that is known to have made “Bob Woolmer” type announcements.

So for me the most important debate that we should be having today is what will happen to the price of oil and consequently Jamaica, and not the role playing of the PNP in the “Silence of the Lambs” Light Bulb Scandal. The oil threat is something I wrote about again just two weeks ago and will continue to do so to try and encourage the much needed debate on this subject that will affect Jamaica’s fiscal accounts, balance of payments, inflation, and the life of every ordinary Jamaican.

Record oil prices
Last Thursday oil hit a record high of US$105.72 per barrel (at the time of writing) and by all indications is set to rise further. I had indicated that it was expected to go to between US$110 to US$120 per barrel by April/May 2008 and at the current rate could very well get there before then. What is even of more fundamental importance is that the analysts are now positing that there may be some fundamental demand problem, and not just the previous speculative pressure that was being touted. This is significant as if there is a demand problem causing the price to increase then it means that this is a greater support for oil prices to rise than any speculative reason.

There is no doubt that if something is not done to check the consumption of oil in Jamaica that we could soon be faced with a US$3 Billion bill annually. The NYMEX Crude Oil Futures chart shows the upward trend of the price of oil since March 1, 2007 when it was around US$62 per barrel to its present level of over US$105 per barrel. This is an increase of over 2/3, or 67%, in one year. If Jamaica, or any country, had inflation of 67% in one year we can just imagine the devastation to every day economic life.

What is even more important is the trend that is illustrated in the chart. The 90 degree line, labeled R, is the up trend support line, which shows that the price of oil is definitely trending up. For there to be a convincing start to a down turn in the price of oil, it would have to fall below this trend line support, which would mean a fall below the US$88 to US$90 per barrel, at current prices. But of some significance supporting the up trend argument also is that oil has consistently broken though key resistance levels, consistently making new highs. As long as new highs are being achieved then there is little hope of any reversal. The first major resistance it broke through was around October 2007 when it passed US$88 per barrel (S2) and secondly in February 2008 when it passed US$100 (S1) per barrel.

What we have to look for to determine if the up trend is weakening is if the next move up to another major resistance level is at the same rate, and of the same size as the move between US$88 and US$100. In other words, it took four months to move from US$88 to break through US$100, and it was a move of US$12 per barrel. If it takes us six months to move from US$100 to US$110, then this would be an indication that the trend could be slowing and could mean that demand for oil at the higher price is becoming less as consumers adjust their consumption patterns.

Immediate fiscal policies
All indications though are that in the near term there is a strong up trend, which means that unless there is some increase in supply or drastic reduction in demand then the price will continue to move up. The evidence is also pointing to the fact that the US economy will continue to weaken into the second quarter, which means that the pressure will be maintained for the price of oil to continue its upward trend.

If the price grows at the same rate then we would be looking at US$110 per barrel by April 2008 and US$120 by June 2008. This would mean that for the six months oil would be averaging over US$100 per barrel. This is quite significant for Jamaica and will certainly have some amount of inflationary pressures, in addition to the other imported inflation we are experiencing. For oil prices to show any significant move down it will first have to go down past the current major support level now of US$100 (S2) and then break the uptrend support line (R) before closing below US$88.

The implication for Jamaica is that immediate fiscal policies are needed to address this fundamental threat, as longer term energy solutions, such as alternate energy sources may be too little too late. Even the more immediate alternate energy possibility of solar energy in homes and businesses would take time to implement any support and the equipment itself. This means that the greatest benefits will only come from fiscal policies to drastically curb consumption.
In the mean time I expect that the US economy will continue to weaken and the interest rate reductions by the Fed will not have any effect short term effect on the causes of the underlying weakness. If the Fed had significantly reduced rates six months ago that would have been a different story but they have waited too long, and so consumer demand has been affected. This is what could happen to Jamaica’s economy is we wait too long to curb our energy consumption patterns, as economics is as much about timing as it is about behaviour.

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