Page 52 - Aamir Rehman Gulf Capital and Islamic Finance The Rise of the New Global Players

CHAPTER 1 Floating on Wealth 37

Downward Pressures

On the one hand, certain foreseeable pressures could keep oil prices
low for the medium to long term, and could (possibly) reduce the cur-
rently enormous importance of oil to the global economy. First, a pro-
longed global recession could keep fundamental demand for oil
lower than it was during the boom years of the 2000s. Household con-
sumption of oil for heating and for driving is, relatively speaking,
fairly inelastic (although some individuals can, of course, trade in
gas-guzzling SUVs for fuel-efficient compacts or switch from oil heat
to other alternatives). A greater cause of elasticity in oil demand is
changes in consumption by manufacturers that use oil as an input. As
demand for all sorts of manufactured goods (appliances, machines,
toys, clothes, and so on) has slipped, factories have started operating
at lower capacity or even shutting down. Furthermore, fewer ships
and trucks with lighter loads are needed to transport the goods to
market. The aggregate effect is that less oil is needed, putting down-
ward pressure on the trading price of the commodity. If the recession
lasts several more years, depressed demand for oil could become the
new norm.
While a recessionary environment naturally lowers the demand
for oil, in some ways it also tempts certain oil producers, especially
smaller ones, to increase production. Producers know, of course, that
higher production pushes market prices down. However, short-term
budgetary pressures are sometimes so great that countries will choose
to sell more (even at a lower price) in order to meet their immediate
needs. The Gulf states tend to be highly compliant with OPEC produc-
tion quotas—as the most important members of the cartel, they need
to be, or else the system would fall apart. Smaller oil producers, how-
ever, have been known to break away from quotas in order to generate
immediate income. If the global recession deepens and extracts greater
human costs, governments will feel added pressure to cash in on their
natural resource wealth. In addition, worldwide oil exploration is con-
tinuing, and new sources of oil have the potential to meaningfully add
to the world supply. Additional discoveries, aided by ever-improving
technology, make oil less scarce and therefore less valuable.
A third downward pressure, and perhaps the most profound, is
the spread of viable substitutes for fossil fuels. As was the case during
previous oil price booms, the boom of the 2000s has led to increased
momentum toward developing and marketing alternative energy
sources. It is worth noting, for instance, that the US Department of
Energy was itself established in 1977, in the wake of the oil booms of