Revving Demand Will Keep Oil Prices Up

With almost all world's major economies now growing, OPEC is pursuing a new strategy: let rising oil demand pump up prices and thus replenish the finances of cash-strapped members.

At its June 15-17 meeting, the oil cartel agreed to hold the production quota steady at 24.5 million barrels per day and called off the September meeting as a signal that the quota would stay in place until 1995.

In the past, the need for cash led to extensive cheating. But this year, OPEC has kept dverproduction to just 1.5% above the quota set in March, boosting oil prices by 25%. By the June meeting, the average price of crude traded globally hit $18.87--the highest in a year (chart).

OPEC is hoping that a growing global economy will do what the cartel has been unable to do since 1985: lift oil prices to $21 per barrel. The International Energy Agency forecasts that world demand for OPEC oil will rise to 25.7 million barrels a day by the fourth quarter, as stronger growth takes hold in Japan and Europe. Add in the uncertainty about Korea, extremely low inventories, and increased speculative buying by hedge funds, and oil prices could hover around $20 in the second half of 1994.

An increase in supplies could offset some of the growing price pressures. For now, Iraq seems unlikely to start pumping oil before 1995. But nonmember Russia could export as much as 2.4 million barrels a day--equal to Venezuela's output.

What will rising oil prices mean for inflation? Because crude is priced in U.S. dollars around the world, strong-currency nations such as Germany and Japan will not feel much of a cost pinch. In fact, the price of oil denominated in yen has fallen 2.8% since January. In the U.S., rising oil prices will be offset somewhat by the greater fuel efficiency of its economy and the stellar gains in factory productivity.

The big losers may well be the industrializing nations whose currencies are tied to the dollar. That's especially true for Asian countries such as Korea, Singapore, and Thailand, which are just beginning to wrestle with rising inflation. For OPEC, however, increased energy demand will enable members to improve their balance sheets this year. And it paves the way for an increase in output quotas in 1995.

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