Oil is trading around $112 a barrel this morning. Putting things in perspective, the price of oil today is higher than the level seen in the 2005-2006 period when the world economy was growing at a faster pace and the economic challenges of 2012 were not on the horizon.
There are several factors that will influence the price of oil in 2012. First, geopolitical risks such as the Iran controversy and vulnerabilities in the Middle East could lift oil prices and bear adversely on global economic stability. Second, Saudi Arabias aspiration to let crude oil trade at current levels to help fund its expenses arising from the generosity extended to its citizens after the financial crisis suggests that oil prices could hover at upwards of $100; this price is higher than the previous de-facto price of $75. Third, Chinas growth path is another important determinant of oil prices in 2012. Real GDP of China grew 8.9% from a year ago in the fourth quarter (see Chart 2). Although it came in slightly higher than market expectations, the fact remains it is a weak performance. Chinas GDP is projected to grow around 8.0%-8.5% in 2012. Large variations of this estimate will have a corresponding impact on oil prices.
Fourth, the European debt crisis and its impact of economic growth of the region is another significant factor that will influence oil prices in 2012. It is nearly certain that Europe will experience a recession in 2012. The reduction in imports of Europe as a result of the downswing in economic activity should translate to setbacks in economic growth among its trading partners such as China and the United States, which in turn will affect demand for oil. The net impact of these four factors on the supply and demand of oil is uncertain, but price volatility in 2012 is nearly certain.