Crude estimates: in September, CIBC World Markets suggested that oil would hit US$100 a barrel by 2007. So, should we expect big changes in world trade? Some experts think not.

On September 7, CIBC World Markets Inc. published a report that suggested oil prices would hit US$100 a barrel by the fourth quarter of 2007. The report created some excitement, and raised an interesting question: If oil did hit US$100 a barrel, would it change the way we do business?

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Jeffrey Rubin, an economist at CIBC, in his introduction to the report noted that "it had become increasingly evident, even before (Hurricane) Katrina's storm clouds, that energy prices are on a much steeper trajectory than we had initially forecast in April." Originally, the CIBC World Markets team had predicted a target of US$65 per barrel by the end of 2006. Now, with global crude demand growth at between 2% and 2.5%, down from last year's near-record rate of 3.6%, they suggest that that is no longer realistic.

Trade changes?

"It's taken a roughly 50% increase in crude prices to induce that slowing," states Rubin. "Thanks largely to the growing weight of China's oil consumption, the global price elasticity of crude demand now appears only half our initial price elasticity of 0.15, pointing to much steeper price increases to rein in demand growth."

Rubin also factors in the long-term effects of Hurricane Katrina on the planned addition of more than half a million barrels of daily production over the next two years in the Gulf of Mexico. His team's expectations for 2006 are an average price of US$84, and an average of US$93 in 2007.

The report suggests that with such a spike in oil costs, world trade would be shaken substantially, leading Canada to look to Mexico as a now cost-competitive supplier compared to China.

"A comprehensive World Bank study, which examined the link between transport cost and trade in 103 countries, found that a doubling in transport costs from its median level can lead to as much as a 50% decline in world trade volumes," states the report.

"All of a sudden, proximity to major markets becomes far more important in determining comparative advantage," it concludes later, after considering the effects of shipping costs in some detail. The report suggests that US$100 a barrel for oil would be about equal to a tripling of current tariff rates.

... Maybe

But other experts argue that $100 a barrel is unlikely.

"We could say anything is possible," accepts Richard Schuster, oil specialist with Export Development Canada. "Our medium to long-term forecast is that prices will ease off to between US$55-$65 next year, and drop to as low as US$45 by 2010. It could hit a spike of US$100 a barrel but it's highly unlikely to stay there."

Such wildly divergent forecasts seem surprising, but the difference between an optimist and a pessimist is broad when it comes to the oil patch. The CIBC report stresses the loss of supply in the Gulf of Mexico. Schuster, on the other hand, emphasizes opportunities in the oil sands, and potential capacity increases in Russia and Saudi Arabia.

"There is a lot of interest in investing new money in the tar sands right now, and we should see production improvements there and the development of non-conventional sources of oil," Schuster notes.

"You have to consider that, this past year, production was down in western Canada and the rest of the world for a number of reasons, and this shouldn't be a long-term concern," he continues. "Also, there are other parts of the world where there are excellent opportunities. With all of the money currently being invested in Russia, it's likely that some of that money will be used to increase capacity."

Schuster insists that there's a logic to the high prices and a logic behind why they'll eventually drop.

"Refining capacity and import facilities were knocked out by Hurricane Katrina--we have a logical explanation for that," he stresses. "We also have a reasonable explanation of where higher capacity will come from."

Adapting in China

Schuster also stresses that increases in oil prices should eventually affect China's appetite for the resource.

"At the moment, oil is heavily subsidized by the government in China," he says. "In Canada and the U.S., with globally-driven pricing we respond to price changes because those come right down to us at the pumps. But in China, retail pricing is fixed, so oil companies buying on the open market have to be subsidized by government to handle the shortfall. If the price of gas goes too high, the Chinese government won't be able to support this practice, and prices there will rise. We have seen some shortages and rationing in China recently, and the government has tried to push up the retail pricing, but we're talking a 10-15% rise on perhaps 50 cents a litre--comparatively speaking, not a bad price."

In the short term, at least, Schuster certainly sees no changes in the offing with our trade practices in China. "Finished goods prices aren't rising appreciably, so I don't see anything happening any time soon," he says.

With the recent fuel price spikes, and the likelihood of more in the future, some manufacturers will probably concentrate more of their strategy on developing their North American business ties.

Michael dos Santos, CMA, FCMA and president of Flextor Inc. is one business professional who is looking closer to home for parts suppliers due to increasing fuel costs.

"There is a ricochet effect on all other combustibles such as coal, and increases in pricing of metals and cement, which are big consumers of energy," he says. "This is having a direct impact on us, although most of it is good right now, as our customers invest to optimize and reduce oil use."

The question now is, will the risk of pursuing business overseas get higher? The next two years should tell us a lot.

Robert Colman is editor of CMA Management.