Background of the Increase in Oil Prices and Prospects for the Future

Oil Price Trends

The price of WTI oil, the indicator of North American crude oil, was under $60 per barrel at the beginning of November 2006, which represents a significant decrease compared with the $75 per barrel level at the beginning of 2006. Whether or not oil prices will continue to drop, will maintain at the current level, or will rally once again is a big issue for the future.

Looking at the transition of oil prices in recent years, after the 9.11 simultaneous terrorist attacks in 2001, WTI crude oil prices dropped to under $20 per barrel, a reflection of a stagnating global economy. In the following six months, oil prices recovered to reach the pre-9.11 level of over $25 per barrel. Oil prices temporarily showed a sharp increase after the US invasion of Iraq in March 2003, but the surprisingly quick fall of Baghdad led to a drop to under $30 per barrel and it was believed that it would stay at that level. However, minor fluctuations aside, oil prices have steadily and consistently increased since the middle of 2003, and in the beginning of 2006 WTI crude oil reached a high level of $75 per barrel.

Reasons for the Increase in Oil Prices

Why did oil prices rapidly increase? Why were new highs repeatedly set from 2003 to the beginning of 2006? These are significant questions. A steady increase in energy demand amidst a healthily growing global economy, as well as the factor of unstable oil supply are both considered reasons for the continuous increase in oil prices. The basic factor in this price surge does indeed seem to be the demand/supply relationship.

Before oil is consumed by consumers, it must pass through the stages of crude oil production, transport, refinement, and sales. Trouble in any of these stages results in a spike in prices. With regards to crude oil production, one major subject of interest is whether the supply amount can be sufficiently ensured in the future. As production continues year after year, the amount of produced oil, which is an exhaustible resource, gradually accumulates, and at the same time the remaining amount of oil reserves steadily declines. Eventually an oil peak, or the point when the existing production amount surpasses the remaining reserve amount, will arrive.

The spate of conflicts erupting in the primary oil producing Middle East region (beginning with Iran, Iraq, Palestine and Israel) represents a significant instability factor in terms of short-term oil supply. With regards to oil refinement, as the enhancement of domestic refining capabilities has stagnated in the US (the world's greatest oil consuming nation), its oil demand has steadily increased leading to concerns over shortages in oil product supply. In particular, stricter US environmental regulations both regionally and by state have made it difficult for oil products to be converted, so that even though oil product supply is sufficient in the US as a whole, shortages in individual states keep oil product prices high. This, in turn, has resulted in a situation where the oil prices of WTI, the indicator of North American crude oil, are also maintained at a high level.

Furthermore, speculative money has also greatly contributed to the maintenance of high prices on the New York Mercantile Exchange (NYMEX), the North American commodity futures market. In this way, demand/supply factors coupled with the element of speculative money have generated high crude oil prices.

Future Trends of Oil Prices

Looking at recent trends (November 2006) in the supply of crude oil, as the summer supply period for gasoline in North America ended the crude oil supply amount was easily sufficient, and global oil demand had leveled out at 85 million barrels per day. As a result, starting with North America the total amount of global crude oil and oil product reserves has reached the largest in history. While the climate in Iran and Iraq continues to be volatile, in terms of crude oil exports as long as there are no unexpected　incidents in the primary crude oil producing regions of the Middle East, Russia, Africa and South America, concerns over supply should continue to subside. Therefore, if it turns out to be a warm winter in North America and Europe, there may even be a need for OPEC to cutback on crude oil production by the end of the year.

Therefore, in the absence of sudden and major incidents in areas such as the Middle East, or drastic change in Iraq and Iran and development into a crisis of crude oil export disruption, it is not likely that another scenario of rapid increase in crude oil prices will emerge. However, a look at Japanese domestic oil national average prices in October 2006 shows high octane gasoline at 152yen per liter, regular gasoline at 141yen, diesel (store price) at 118yen, and kerosene oil (store price) at 83.5yen. While these prices are lower than in August or September, in general oil wholesale distributors bear a part of the burden of a sharp increase in crude oil price, and transport companies also cannot transform the increased portion of gasoline and kerosene price inflation into money. In other words, they are in a situation where they continue to suffer. If crude oil prices experience great fluctuations in the future, it could have an extremely large impact on Japan's industries. There is no choice but to continue to closely monitor the trends of oil prices in the future.