The Oil Market and The Financial Crisis Part II

The oil market and the financial crisis 2

4: 2000s with increased oil prices – cause

In the years 2003–07, oil prices rose gradually, driven by unexpected growth in consumption and scarce supplies due to storms and disruptions in oil production in the US Gulf of Mexico (2005). In addition, the political risk increased as a result of the Iraq war and the sharpening of relations between the United States and Iran. The background was that from 1980 to 2000, global oil consumption increased by 1–1.5 per cent annually. During the same period, however, the real price of oil fell. This provided weak incentives to invest in new oil fields.

In the summer of 2003, the oil market expected that the United States would gain control of Iraq, that Iraq’s oil production would increase and oil prices would fall. During 2004, it became clear that the United States had no control over Iraq and that oil production in Iraq would not pick up. In the same year, demand for oil rose unexpectedly sharply, by 3.5 per cent; 60 percent of the growth took place in China and the United States . A testimony to US trade authorities claims that the rise in prices in 2007-08 was due to a shortage of light oil with a low sulfur content, caused by stricter quality and environmental requirements for refining in the US together with interruptions in extraction in Nigeria.

A further reason for the rise in oil prices may have been the fall in the dollar against the euro. The oil-exporting countries in the Middle East and Africa, like Norway and Russia, have the majority of their goods imports from Europe. They therefore have an interest in maintaining the terms of trade with the EU and the oil price in euros . At the same time, oil prices have been more stable in euros than in dollars. This suggests that it may have been rational to take positions in oil to hedge against a fall in the dollar. From 2002 to 2008, the oil price quadrupled in dollars, while in euros it increased two and a half times. The real rise in oil prices has thus been stronger in the United States than in the euro area. This became noticeable at the end of 2007.

A recent reason for the rise in oil prices, especially from 2007 to 2008, may have been speculation from financial players in the market, not least investment funds. No evidence has been presented that financial players have manipulated the oil price up, but when a large number of such players appear in the paper market for positions – not physical, commercial transactions, they strengthen demand and drive the price up. In the spring of 2009, it was claimed in the American press that the investment bank Goldman Sachs had first contributed to a speculative risein the oil price in 2007–08. The bank then sold itself into the paper paper market, at the same time as the bank publicly stated that the oil price would continue to rise, perhaps to $ 200 / barrel. US authorities recorded a sharp rise in financial players’ positions in commodity markets from the summer of 2006 to the winter of 2008 and then a sharp fall until late autumn.

A study (Baker Institute, Rice University) published in late summer 2009 points out that financial players, defined as players outside the oil industry, probably played a decisive role in the sharp rise in oil prices in 2007–08 and in the subsequent fall in prices. Other studies point out that although the physical balance between supply and demand has undoubtedly had an impact on the rise in oil prices from 2003, it also seems clear that financial actors, speculators, drove the oil price bubble from 2007 until the summer of 2008. One indication is the growth in oil volumes daily. were traded in the paper market, futures. In relation to total demand, it increased from 4.5 per cent in 2002 to over 15 per cent in 2009.

A further indication may be the coincidence of the rise in real prices for gold and oil in the years 2003–08. The gold price is mainly set by financial players and speculators, not by producers and users. In the years 2003–08, the oil price rose even stronger than the gold price. The rapid and sharp decline in oil prices from the summer of 2008 can hardly be caused by a sudden change in the physical balance of the oil market. Rather, the decline was due to financial players seeking to exit positions in oil after first investing heavily.

5: The motives

The motives can be a quick profit (speculation) and to spread risk (value hedging), but also to hedge against inflation and falling dollar exchange rates. In this way, financial players can create bubbles in the oil market when a sufficient number of people want to buy positions in oil, and conversely a fall when many want to get rid of oil positions. There were clear tendencies for oil bubbles from 2006 to the summer of 2008. The fall came in the summer of 2008 and lasted for the rest of the year.

Since the summer of 2008, the oil market has probably considered the risk of conflict with Iran and supply disruptions to be lower. After the economic change, the risk picture has been economic downturns, declines in oil consumption, rising oil supplies and falling prices.

In the second half of 2008, a shift occurred in the oil market and in the foreign exchange market: Oil prices began to fall at the same time as the US dollar began to strengthen. Part of the reason may be that US investment funds have had to sell positions in the oil market to reduce debt in dollars. In the spring and summer of 2009, the oil price has doubled again, at the same time as the dollar has weakened against the euro and the number of financial positions in the commodity markets is increasing. The question is when and possibly to what extent a new oil bubble may arise. The answer depends on the real economy, on the physical balance in the oil market (between supply and demand), on the dollar exchange rate and on alternative investment opportunities for venture capital.

6: Oil bill and financial crisis

The price of oil affects the real economy, but until 2006 probably less than in the 1970s and 1980s due to more efficient use. Less (oil) energy is used per unit produced today than a few decades ago. On the other hand, the price increase from 2006 until the summer of 2008 may have had a stronger effect on the real economy. When the oil price rises, users thus receive less money for other purchases. When consumers’ oil bills get bigger, they can buy less of anything else. A rise in prices hits low-income countries and low-income groups particularly hard.

In this way, changes in the oil price can affect purchasing power vis-à-vis other goods and services, with extensive ripple effects. Historically, a sharp rise in oil prices has been followed by economic downturns. In the US, the rise in oil prices has exacerbated the mortgage crisis and thus the financial crisis by weakening purchasing power particularly hard for low-income groups who were burdened with expensive mortgages.

The loss of income affects the demand for oil. The coincidence of high mortgage rates, high fuel prices and high unemployment has gradually weakened households ‘demand for petrol and transport companies’ demand for diesel. This contributes to affecting the level of economic activity (the real economy).

In a few years, the rise in oil prices transferred several per cent of the world’s total income from oil importers to oil exporters . The combination of increasing oil consumption and rising oil prices led to the world oil bill (roughly calculated from the price of Dubai crude oil) rising from approx. $ 700 billion in 2002 to an estimated over $ 3,000 billion in 2008, or from 2.2 percent of the world’s gross domestic product in 2002 to 5.1 percent in 2008. This is still well below the level from 1980, when the oil bill was estimated at 7, 5 percent of world GDP.

The negative impact on high oil prices on the real economy has probably been stronger in the United States than in many other countries. Some key reasons are a relatively high consumption of fuel and a weakened currency alongside a skewed income distribution. The prices of petrol, diesel, heating oil and natural gas rose sharply from 2006 at the same time as house prices fell and house rents rose. As mentioned, this particularly affected low-income households, which in many cases had to give up their homes and inflicted losses on banks. In the United States, the oil bill in 2008 amounted to an estimated 5 percent of GDP, which was well below the level of 8.5 percent in 1980 (calculated on the basis of the price of American light oil, WTI).

7: Lower energy bill – different effects

An estimate for 2009 shows a significant decline in the world economy . But since the decline in oil prices is relatively stronger, the world oil bill is reduced from 5.1 percent to 3.4 percent of world GDP. The fall in oil prices in 2008–09 reduces the world oil bill by an estimated $ 1,200 billion. That is, as much as the sum of the measures in the G20 countries to stimulate the economy.

In addition to the reduction in the world’s oil bill, there are lower prices for natural gas and coal. The total decline in the world’s energy bill will thus be just over 2 per cent of the world economy. According to, the refusal of the world’s oil bill paid by OPEC -l andene and other oil-exporting countries , primarily Canada, Mexico, Norway and Russia. OPEC and especially Saudi Arabia now seem to prefer a recovery in the world economy to higher oil revenues. In 2009, Saudi Arabia completed investments that bring the extraction capacity up to 12.5 million barrels / day. With an actual recovery of 8 million barrels / day, the country has a spare capacity of 4.5 million barrels / day and a significant opportunity to intervene in the market.

Lower oil prices weaken inflation, strengthen the trade balance of importing countries and contribute to economic recovery. At the same time, low oil prices provide weak incentives for energy savings and lead to a decline in oil and gas investments. Low oil prices also weaken the development of alternative energy sources. The risk for consumers is that a future economic recovery strengthens the demand for oil and gas after the supply has been weakened. The growth comes primarily in countries outside the OECD area , which increasingly have to compete with new buyers in the oil market, which will increasingly be characterized by Europe, Japan and the USA.


The oil market and the financial crisis 2