Oil price leaps to year's high  

The steadily rising oil price is starting to grab headlines again, as puindits begin to notice that even though we are in the midst of a global recession the oil price is still well above the levels of 2 years ago. The Guardian had a report mid-week - Oil price leaps to year's high.

The price of oil burst through the $71 a barrel mark today amid revelations that proven reserves had fallen for the first time in 10 years and predictions that the price could eventually hit $250.

The latest high – from lows of $30 only four months ago – came on the New York Mercantile Exchange, where the cost of July deliveries rose by $1.35 to $71.36.

This comes on top of a $2 rise the day before as investors rushed into the market on the back of lower stockpile figures, higher demand estimates and speculation against further falls in the dollar.

"I wouldn't be surprised if we're testing $80 in a week or two," said one analyst, while BP's chief executive, Tony Hayward, questioned whether $90 could be the "right" value.

Kuwait's oil minister, Sheikh Ahmad al-Abdullah al-Sabah, put some of the rise down to signs of recovery in Asia but warned that overall demand was still weaker than last year. Opec would not raise supply at current oil prices but did not rule it out "if it reached $100", he said.

Alexei Miller, chairman of the Russian energy group Gazprom, raised the stakes further when he reiterated last year's estimates of $250 a barrel. "This forecast has not become reality yet, given that the [credit] crisis gained momentum and exerted a powerful impact on the global energy market. But does this mean that our forecast was unrealistic? Not at all."

The latest surge has also raised fears that higher energy costs could snuff out the nascent economic recovery. Shares on Wall Street's Nasdaq index fell 1%.

The febrile atmosphere in oil markets was fed by the publication of BP's Statistical Review of World Energy, which showed that the world's proven crude reserves had fallen by 3bn barrels to 1.258tn by 2008 from a revised 1.261tn in 2007.

Declines in important producers such as Russia and Norway offset rises in new areas such as Vietnam, India and Egypt. The figures did not include Canada's tar sands, which are put at 150bn barrels.

The drop is partly attributed to a drop in exploration drilling due to the precipitous fall in oil prices last year but also to the end of "easy" oil. Conflict this week in the Amazon and speculation about Arctic drilling underlined how oil companies are pushing into environmentally sensitive places to find new reserves.

Tony Hayward, BP's chief executive, insisted there was enough crude to last 42 years at current consumption levels, roughly the same as last year. Adherents of "peak oil" – the theory that the maximum rate of oil production has been reached – believe supplies will run out much sooner because of growing demand.

There are two ways to explain the rise in commodity prices, which now far outstrips the rally in equities. Crude oil is up more than 120 per cent from its low.

Conditions in the oil market have been so bizarre that they distort perception. Anchor on the price 12 months ago, and oil has halved; take six months ago as a base, and oil has doubled. All of this has been without any significant interruptions in the oil supply or geopolitical events.

If we put aside the distorting lens of oil, moves in the commodity complex are less dramatic but still hard to explain. According to the Dow Jones-AIG commodity indices, energy futures as a whole are down 66.6 per cent from their peak but up 40.1 per cent from their low; industrial metals are down 47.4 per cent from the top but up 47.8 per cent from their trough; and agricultural commodities are still 317.1 per cent below their high from last year but up 34.3 per cent from their low.

One explanation is the cheese shop scenario; that demand is drastically outstripping supply. Manufacturers across the world leapt to close off production last year, either because they expected lower demand or because the credit crunch meant that they could no longer get financing.

Thus we could now be at the beginning of a classic restocking bounce, as the inventory cycle turns; businesses overshot during the shock to the economy last year, and with new orders now exceeding inventories they may be about to overshoot in the other direction. Such effects can be pronounced for commodities, where the decision to close a mine, or to turn over farmland to some other use, can constrict supply in a way that cannot be quickly reversed. Manufacturers can feel like Cleese in the cheese shop.

These arguments do at least suggest that the economy is growing. But they also suggest that growth is constrained. If there are not enough essential commodities to go round, then prices will have to go up.

This fear was vivid 12 months ago. With respect to oil, it is known as the peak oil thesis – that oil production has peaked and that supply will steadily reduce from now on.

The idea also coheres with the concept of a commodity “super cycle”. Over history, commodity prices tend to move horizontally for periods of a decade or more, then spend a decade or so in an upswing. The upswings can be interrupted by sharp falls or “corrections”.

Chris Watling of London’s Longview Economics points out that last year’s steep falls and the subsequent rebound closely resemble the mid-cycle corrections of 1937 and 1974.