Oil is calling the tune, but who really wins?

With crude surging in price, an economic imbalance has fuelled inflation fears. But there are signs of brighter days ahead - it is all just a question of relative values.

Crude oil prices are on the rise, at least in dollar terms. (AP Photo/Hasan Jamali)

Crude oil prices are on the rise, at least in dollar terms. Last month there was another wave of crude price increases - a sustained and persistent increase since the "lows" of US$60 a barrel in late 2009.

OPEC's reference basket of member countries' crude prices moved to the $85-$90 per barrel range last month, up some $5 from a month earlier. Nobuo Tanaka, the executive director of the International Energy Agency (IEA), weighed in this month to state his concerns over the rise, warning that although global petroleum stocks were high, they were declining.

Commentators have been quick to try to explain the factors behind the rise. Notably, there has been continued improvement for the fortunes of emerging market economies. In the northern hemisphere, we have also had an earlier-than-expected winter, increasing demand for heating oil and a decline in crude stocks.

If it were simply a matter of balancing supply and demand, OPEC currently holds about 6 million barrels a day spare capacity that can be made available to the market. Crude inventories in the US remain above a five-year average, and according to the IEA monthly market report, "other OECD [Organisation for Economic Co-operation and Development] regions, such as Europe and Japan, have even experienced counter-seasonal builds". In other words, stocks are rising at a time of the year when they should be falling. The IEA's view? The recent surge in prices cannot be fully explained by a change in oil market fundamentals.

While these comments from the IEA are correct in their respective secular contexts, the crude price per se understates a converging dynamic that confounds explaining the relative value of oil in supply and demand terms.

Some analysts have suggested that there may be speculative forces at work. Others have tended to focus on the value of crude oil relative to other commodities. Prices for corn and wheat are up by more than 40 per cent, and precious metals mimic the same escalating patterns.

What economists have not rushed to point out, however, is who has benefited. Perhaps rightly so, because price increases of certain commodities infer economic rights to some groups over others, and such political insight rarely falls under an economist's reporting remit.

In broad terms, a rise in the price of oil for petroleum exporters typically marks an increase in their treasuries, and by association an increase in spending power. It can also be used to mark an increase in national growth - more income is being generated for the same number of inputs. Seemingly obvious.

What they do not go on to explicitly say is that such endowments are both temporal and conditional. Temporal because if such treasuries are not divested, merely by the nature of fossil-based energy as an input cost to production on all continents, the purchasing power of treasuries is eroded relative to the output prices of products that rise over time to accommodate for more expensive energy inputs, also known as "pass-through". Conditional because the nature of spending requires a system-wide approach. Divesting a large pool of funds in a narrow market forces prices up, diluting purchasing power. In both circumstances, the same money tomorrow will buy less than it can today.

The cost pass-through premise is difficult to dismiss. Since the recession of the 1990s, inflation in the OECD has fallen consistently. Falling costs of leading inputs tend to lower the lagged output prices, which then lead to progressively lower inputs. Lower inflation has also meant interest rates have trended progressively down. The risk now seems to be on the reverse. Nearly every major input cost is on the up.

The difficulty in identifying the winners and losers is that the debate over crude prices comes in the midst of a recession and a "currency war". If we were monetarists - a tradition that believes inflation comes about because too much money is chasing too few goods - then the overall rise in commodities might well be explained by governments printing money. The relative value of one currency against another depends on who prints more and seamlessly passes on the dilution of wealth beyond their shores. The two US rounds of quantitative easing are no exceptions. Nor is it a secret that the Chinese central bank has allowed money growth over the past decade to curb the yuan's appreciation against the dollar. While the policy has helped to preserve a competitive advantage among Chinese exporters by keeping their prices relatively low on global markets, there are now signs that this could be waning. Put differently, there is now a real possibility that the combination of a loose monetary policy in the US, coupled with monetary tightening in China (to prevent the economy from overheating), that the same dollars this year will buy you markedly less than last year.

Inflation in OECD countries also seems to be on the rise, and if inflation accelerates as it did in the UK last month, there is likely to be a broader scramble to preserve wealth. With interest rate policies aimed at curbing inflation combined with the risk of a stalling recovery, it is no wonder pension funds continue to flow to emerging markets such as China, which posted a 9.8 per cent growth rate in the final quarter of last year.

Monetary policies aside, the analysis of commodities is no doubt fundamentally the preserve of vertical industry specialists - upstream, midstream and downstream alike. The actual monetary value of crude produced today is more likely to be the result of investments made in an era long past.

When several commodities rise simultaneously, their geographic and physical interdependencies come into question. If something can be readily measured, it does not mean it should be compared. Simply because many products are classed as consumable commodities, traded on similar exchanges under futures contracts, does not mean the industries operate under the same dynamics.

Valuing crude relative to other commodities would make sense if the causality had an association, either by the laws of physics or at least in theory, however imagined. And in probably the most obscure sense, wheat grain may play a part in producing oil and vice versa, yet the physics of the association hardly warrant a direct comparison. If there was, why not price the cost of a kilo of rice in terms of barrels of oil?

Determining the winners and losers of price movements in commodities is just as difficult as isolating the reasons for the price increase in the first place. The value of something is not always its cost - and when collective buyers and sellers are organised into an exchange in which not only the seemingly uniform commodities are sold, but also the value of the currencies that are brought forward to buy the commodities in the first place, value becomes an obscure proposition.

There is hope that a clearer picture will emerge as winter draws to a close. Bullish market sentiments may recede, or they may simply be buoyed by a brighter 2011. Is this a new era of rising inflation epidemic? I don't think so. Are we likely to face an ever-higher cost of living? Much more likely.

Ikaraam Ullah is an economist and writer based in the UAE