Economic Developments and Monetary Policy


BOX 10

MAS undertook a study of the global crude oil market in 2004, against a backdrop of a rapid increase in prices to record highs to above US$50 per barrel (see Chart 18). We found that the price increase can be explained by a combination of demand and supply factors.

Apart from strong U.S. demand in 2004, demand from China and India has also risen dramatically (See Chart 19). While cyclical factors were partly behind strong Chinese demand, structural factors such as the shift towards energy-intensive heavy industries and a rise in car ownership have also played a part. In contrast to the early 1990s when China could meet all its oil needs from domestic production, it now relies on imports for over one-third of its requirements. On the supply side, global oil production is now at near full capacity due to a lack of investment over the past two decades, which limits the extent to which future supply could increase to meet any projected rise in demand (See Chart 20). Other longer-term supply factors driving up prices include higher production costs faced by oil producers as a result of higher taxes and tougher environmental regulations, as well as rising upstream and transport costs.

Apart from demand and supply fundamentals, fears of supply disruptions, such as those caused by saboteurs in Iraq, have also resulted in a “security risk” premium on oil prices. Speculators have also fuelled part of the run up and volatility in prices.

In the short-term, the oil market will remain volatile over events that could result in supply disruptions. In the longer term, high oil prices are likely to stay, albeit not at current levels. On the demand side, the secular rise of energy-intensive emerging markets, especially China, represents a permanent positive shock to global demand. On the supply side, capacity will remain tight in the next few years, as new investments will take a while to come on stream. For all these reasons, the long-term price of oil is likely to rise significantly above the US$14 to US$22 per barrel range seen throughout the 1990s.