THE BLOG
07/23/2009 05:12 am ET | Updated May 25, 2011

Will Oil Prices Surge?

It was only a year ago when the price of a barrel of oil surged above $140. Indeed, amid charges of oil price manipulation by greedy speculators, several leading contenders for the 2008 U.S. presidential race seized on the escalating petroleum price as a major campaign issue. Remember when senators Hillary Clinton and John McCain offered to eliminate Federal gas taxes as an inducement to desperate voters?

The Global Economic Crisis, emerging with full fury after the near collapse of the world's financial system last fall, brought about an even more spectacular collapse in oil prices. Recently, amid reduced demand sparked by a synchronized global recession, the price of a barrel of black crude descended below $40 a barrel, sending OPEC into fits of despair.

Now, however, the price of oil is once again moving upward. In part, suggest analysts, this is due to a perception that the worst of the economic free fall is behind us. Whether those perceptions are valid or not (and I don't believe they are), psychology is an important factor is establishing commodity valuation. However, I believe there are other forces at work, or which may intervene in the future, that could radically escalate the price of hydro-carbon energy irrespective of recessionary constraints on consumption. Here, briefly, are factors to consider in anticipating any future oil shock:

1. China hedging on oil. Apparently, the Chinese are shifting investments allocated from their sovereign wealth fund from U.S. Treasury bills to commodities, including oil. With a sharp drop in exports only partially redressed by a stimulus-funded drive at boosting domestic consumption, it appears that China is building up an oil reserve in anticipation that this commodity will eventually rise greatly in price, simultaneously with the future depreciation of the American dollar. Should China's oil hoarding increase in tempo, a significant upside in the price of petroleum will become highly probable.

2. Political instability in the Persian Gulf. The political upheaval occurring in Iran in the aftermath of a presidential election widely perceived by the Iranian people to have been rigged has an unpredictable dynamic. However, most scenarios, either involving prolonged violence or the perpetuation of a radical regime committed to acquiring nuclear weapons, will likely facilitate events that will impact the supply of oil from the most energy-intensive real estate on the planet. Even the mere perception that things might go bad will be enough to drive up the price of oil. Actual events, including internal and external violence, will impose a significantly higher cost penalty.

3. A terrorist attack involving a strategic target related to the oil industry. Al-Qaeda is well aware of the vulnerability of the global economy, at a time of profound financial and economic crisis, to a targeted attack on a vital element related to the oil industry. Only one single but highly significant target would be enough to send the price of oil to a much higher level. Unfortunately, Al-Qaeda and its allies have many choices to select from a menu of targets. In terms of extraction, transportation to consumers as well as refining and storage infrastructure, there are literally thousands of targets across the globe, any one of which would prove impactful to the stability of oil prices. It would be unduly optimistic to assume that Al-Qaeda is not focussed on such an objective, or that security forces are so effective that they can protect every possible target.

The fall in oil prices from their record highs of last summer amounts to, in effect, a tangible economic stimulus program. Unlike government stimulus spending programs, the fall in oil prices required no deficits, and meant an immediate infusion of money into the pockets of private and corporate consumers. Conversely, the return to higher energy prices at a time in which the world is experiencing its worst economic crisis since the Great Depression of the 1930s would, in terms of impact, be a major tax penalty being imposed on any attempt at a sustained recovery. In essence, the entire global economy is being held hostage to the volatile pricing forces of an essential commodity. Clearly, when it comes to oil price levels, the market does indeed rule.