By Debasish Roy Chowdhury (China Daily)
Updated: 2007-11-22 07:13

What ails oil? The world gropes for an answer as it barrels toward the $100 mark, threatening to bring in its wake a host of adverse socio-economic consequences ranging from recession to popular discontent. The answer, as some would like us to believe, is strikingly simple: China. Nothing could be further from the truth.

The International Energy Agency (IEA)'s World Energy Outlook 2007 predicts China will overtake the United States as the world's top energy consumer after 2010 as global energy demand jumps 55 percent in the coming 23 years.

According to the IEA, China and India will lead this surge in demand, accounting for 45 percent of the increase, with their combined oil imports rising to 19.1 million barrels a day in 2030 from 5.4 million barrels a day last year.

This will be more than the combined imports of the US and Japan today, the two largest oil importers now. The IEA also expects China to overtake the US to become the world's biggest carbon emitter this year. Inference: China's rapid development is pumping up oil prices.

Not so fast. It would be nice to imagine that oil prices are dictated by demand and supply like other commodities, but they do not. Not anymore at least. The current rally is being driven by a confluence of factors, none of which has anything to do with China.

OPEC leaders in the just-concluded special summit of oil exporters steadfastly refused to increase production in response to the mayhem in the crude market. Many of them made it clear in different forums that increasing supply would not bring down crude prices as oil does not follow market logic anymore.

More than demand and supply, the prime determinant of crude prices today is geopolitics. Some of the sharpest spikes in crude prices in recent months came when Turkey threatened to attack northern Iraq to fight Kurdish guerrilla forces, when violence gripped Nigeria, when chaos and protests rocked Venezuela and as Teheran and Washington relentlessly exchanged bellicose unpleasantries.

The Middle East, which has nearly 70 percent of oil reserves, has been plunged into an abyss of political uncertainty, raising fears of supply disruptions. And China has had no hand in it. As if Iraq was not enough, the Western media is now discussing the pros and cons of an Iran war, conveying the impression that it is in the realm of possibility.

Oil is a political commodity and its price is a product of political risks more than anything else, a fact exemplified by Venezuelan President Hugo Chavez's statement at the OPEC summit: "If the United States is mad enough to attack Iran or threaten Venezuela again then the price will not be $100, it will be $200."

These risks are amplified by speculators. Banks, hedge funds and financial institutions of all hues have flocked to commodities markets, where oil futures are the main draw.

Experts estimate that more than $200 billion is swirling in oil futures, up more than 60 percent from the end of last year. Speculation is not only widespread but also tough to rein in as a chunk of the trading takes place in unregulated markets.

And speculators are quick to seize on the slightest hint of a supply disruption as a result of political risk. Such risks thus automatically translate into what has become to be known as oil's political risk premium, which can range anywhere between $20 and $60 a barrel.

A direct fallout of the paranoia about supply disruptions is the increasingly important role oil inventories are playing on price movements. Even the slightest of changes in US stockpile numbers, or a storm brewing in the Gulf of Mexico threatening supply lines, or weather changes with the potential of causing drawdowns can cause wild swings in prices.

The second factor driving oil prices is a wobbly dollar. Because of its unique privilege of being able to print the world's reserve currency at will, the US has long spent beyond its means as a dollar-denominated trade deficit for it does not pose a balance-of-payments problem.

Decades of profligacy are taking its toll on the dollar. The subprime crisis and the recession it threatens to unleash have dealt yet another severe blow to the beleaguered currency, forcing many international investors to dump dollar and hedge their bets in commodities like oil.

As oil is priced in dollars, whenever the dollar falls, oil producing nations need a higher price per barrel to maintain the same level of revenue as before. And the dollar falls every time the US Federal Reserve cuts interest rates as dollar-denominated investments like treasuries are rendered less attractive.

Faced with the turmoil in the credit markets, the Fed has been forced to exercise that option of late, indirectly pushing up oil prices.

China's growth is not a new phenomenon. Had world oil prices been driven only by China's energy appetite, they would not have dropped toward the end of last year when China's crude imports had risen over 16 percent in the first three quarters. Again, China consumed less crude in 2005 than in 2004, but oil prices kept rising throughout 2005. So the China angle in the oil story is pretty weak.

Of course China understands its responsibilities as a major economy, the reason why it has set the goal of trimming its energy consumption by 20 percent per unit of gross domestic product by 2010 and the country's leaders stress on scientific development that puts more emphasis on sustainability and entails less dependence on resources.

But the fact of the matter is that the US still consumes more than a fourth of the world's oil and China less than a third of what the US does. And neither do movements in China's much-vilified currency affect world oil prices, nor does China create or contribute to volatility in key oil-producing regions and add to geopolitical risks.

China prefers dialogue over pre-emptive strikes, engagement over hostility and reconciliation over rhetoric. This is why the Democratic People's Republic of Korea is not in the "axis of evil" anymore. But oil will always be. Not even China can get it out of there.

The author is a senior editor at China Daily

(China Daily 11/22/2007 page11)