The Fundamentals of the Spike in Oil Prices

CHICAGO, June 4, 2008 — "How can we explain such an extraordinary rally in oil prices? Is the answer as simple as supply and demand imbalances as many in the oil industry would have us believe? Or, is there something more sinister at play, such as speculation or, as some have accused, outright manipulation? Much to our own surprise, the underlying economic fundamentals of the market (i.e., supply and demand) go a long way in explaining the run-up in oil prices in recent years, but cannot alone account for the excessive rise we have seen this year," says Adolfo Laurenti, senior economist of Mesirow Financial, in his June issue of Themes on the Global Markets.

In his June newsletter, Laurenti takes a closer look at factors that have contributed to the most recent run-up in oil prices and shares his forecast for these, including:

• Demand for oil outstripped its supply much of the last decade, with the biggest shortfalls occurring in 1999, 2002, and 2007. This forced economies around the world to dip into existing reserves to satisfy their needs, and ultimately bid up the price of oil.
• The global demand for oil should stabilize and could even weaken slightly, but is not likely to contract dramatically in the near-term. This means that production rather than consumption will have to drive a correction in prices.
• The real responsibilities for insufficient supply are squarely in the camp of the developed economies. Indeed, between 2003 and 2007 production dropped by 0.7 million barrels per day (mbd) in Norway, 0.4 mbd in the United Kingdom, and 0.3 mbd in the U.S. Production in OPEC, on the other hand, was on the rise, increasing by 1 mbd in 2007 alone.
• Reasons for supply shortfalls include: nationally-owned oil companies, which lack the market incentives to increase investment (e.g., Venezuela); systemically low oil prices in the 1990s—$20 per barrel on average—caused a serious shortfall in investment on exploration and new equipment across the developed world; concerns about global warming; and, political instability has interrupted supply routes.

"Oil prices should fall from their recent highs, and stabilize somewhere in the $90 to $100 per barrel range by the end of the year. The timing is tricky, however, and prices could easily top $150 per barrel before correcting. Consumers have begun to react to higher prices, however, and if they do stay that high, demand will fall further in the U.S. than is currently forecast, and prices will come down more aggressively next year," concluded Laurenti.

The June issue of Themes on the Global Markets as well as archived issues can be found at www.mesirowfinancial.com.

Mesirow Financial is a diversified financial services firm headquartered in Chicago. Founded in 1937, it is an independent, employee-owned firm with $32.2 billion in assets under management and more than 1,100 employees in 30 locations across the country and in London. With expertise in Investment Management, Investment Services, Insurance Services, Investment Banking, Consulting and Real Estate, Mesirow Financial strives to meet the financial needs of institutions, public sector entities, corporations and individuals and was named one of Chicago's Best Places to Work by Crain's Chicago Business in 2008. For the fiscal year ended March 31, 2008, the firm posted $490 million in revenue (unaudited), with more than $245 million in capital. For more information about Mesirow Financial, visit its Web site at www.mesirowfinancial.com.

For more information, contact: Adolfo Laurenti, Mesirow Financial, 312-595-7129.

 

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