The Rise and Rise of Oil Prices

Crude oil prices have gone up a staggering eight times in the past 10 years from about $18 a barrel at the beginning of 1998 to $146 a barrel in July. In the past 18 months, itself prices have climbed by over 133 %. The staggering effect it is having on the American economy (which consumes 24 % of world oil output) can be gauged by the fact that over 40 meetings of various committees and sub-committees of the US Congress have been held in the past 11 months to investigate the zooming oil prices.

The principal accused include big oil corporations, governments, oil exporting countries (OPEC) and investment bankers. Some say that the falling dollar is to blame while others point the finger of accusation towards the vast demand for oil generated by India and China.

The global daily consumption of oil is around 80 million barrels. OPEC which consists of a group of 13 oil producing countries made up of Iran, Iraq, Kuwait, Qatar, Saudi Arabia, the United Arab Emirates, Libya, Algeria, Nigeria, Angola, Venezuela and Ecuador account for around two-thirds of the world’s oil reserves, and 35.6% (around 30 million barrels per day) of the world’s oil production, affording them considerable control over the global market. Non-OPEC oil producing nations like Russia, the United States, China, Mexico, Canada, Norway, and Brazil are responsible for producing 60 per cent of the world’s oil and face increasing production hurdles.

Experts say many of the non-OPEC producers have older, less productive oil wells, rising costs for new projects, and in some cases rising demand at home that may cut into exports. OPEC in 2007 announced it would boost production for the first time in two years to ease price pressure over concerns that producers outside the cartel would be unable to meet demand.

Ever since the 1973 energy crisis when OPEC refused to ship oil to western countries that had supported Israel in the Yom Kippur War against Egypt and Syria (that refusal by OPEC caused a fourfold increase in the price of oil, which lasted five months) the west has been wary of Muslim dominated OPEC and routinely blames it for not adhering to its daily production quotas and not producing enough to stabilise oil prices.

The dollar is currently languishing near record lows against the euro after a run of aggressive interest rate cuts from the U.S. Federal Reserve and worries over U.S. economic growth. Since currently worldwide oil sales are denominated in U.S. dollars, changes in the value of the dollar against other world currencies affect OPEC’s decisions on how much oil to produce. Thus the weak dollar is a key factor in spurring many dollar-denominated commodities including oil to record highs, pushing inflation and the cost of living. The U.S. Treasury Secretary Henry Paulson however states that “the dollar has depreciated a little bit less than 25 per cent, since February 2002 while oil has gone up well over 500 per cent and it’s gone up in every currency”.

In a hearing of the US Sub-Committee on Oversight and Investigations, held last week, it emerged that one of the main reasons propelling ever-higher commodity prices (including oil) is the gigantic flow of speculative funds into the futures trading market. It is estimated that investments by pension funds, sovereign wealth funds and endowment funds in commodity futures increased from $13 billion at the end of 2003 to $260 billion in March 2008. That’s a 20-fold growth in less than five years. Today the number of paper oil barrels traded daily on NYMEX (and that’s just the most regulated exchange) is over three times the number of physical barrels consumed daily worldwide.

Some experts say that by a conservative calculation at least 60% of today’s $146 per barrel price of crude oil comes from unregulated futures speculation by hedge funds, banks and financial groups using the London ICE Futures and New York NYMEX futures exchanges and uncontrolled inter-bank or Over-The-Counter trading to avoid scrutiny. US margin rules of the government’s Commodity Futures Trading Commission allow speculators to buy a crude oil futures contract on the NYMEX by having to pay only 6% of the value of the contract.

At today’s price of $146 per barrel, it means a futures trader only has to put up about $ 9 for every barrel. He borrows the other $120. This extreme leverage of 16 to 1 helps drive prices to wildly unrealistic levels and offset bank losses in sub-prime and other disasters at the expense of the overall population. Washington is trying to shift blame, as always, to Arab OPEC producers. The problem is not a lack of crude oil supply. In fact the world is in over-supply now. Yet the price climbs relentlessly higher. Why? The answer lies in what are clearly deliberate US government policies that permit the unbridled oil price manipulations through speculation in the Futures market.

Islam prohibits any fixed return on investment. The idea being as a partner you have to share both profit and loss. In Futures and Options you are hedging yourself against any price fluctuation and trying to get a fixed return at a fixed time. The disastrous effect that speculative trading can have on the zooming oil prices and hence the global economy is crystal clear. We need to go back to the basics or be prepared for another Oil Shock!