Oil rose to $112 a barrel last week as the dollar continued to weaken, while other commodity prices rallied as well. While we think the threat of supply disruptions from the Middle East remain relatively remote, we would note that Saudi Arabia's cost of governing has been rising sharply. In order to run a balanced budget, Saudi Arabia needs to sell its oil for $88 a barrel, up from $68 a year ago, due to increased social spending to quell unrest, according to the Institute of International Finance (IIF). While current prices leave the Saudis with a budget surplus this year, the IIF notes that the break-even oil price to balance the Saudi Budget will rise to $100 per barrel by 2015. We expect this upward trajectory of Saudi 'ruling expenses' to put a floor under oil prices, and limits their ability to be a swing producer. Our current view is that oil will not rise significantly above $120 this year, but if we are wrong, the risks to growth will need to become more defensive.

David Fuller's view This issue also has some interesting comments on China.

Regarding the paragraph above on Saudi Arabia and the price of crude oil it will require in future, an extrapolation of social spending required to keep peace within the Shiite minority community assumes a lack of other options. Developing the economy to create more jobs would seem a better long-term solution.

Whatever, I maintain that the world will face periodic supply inelasticity difficulties in terms of fossil fuels during the next 5 to 10 years, although less so in the USA which has pioneered commercial extraction of shale gas in the last decade and is also now producing shale oil. This should lead to US energy independence within 12 to 15 years. Moreover, as other countries use the same technology to develop their own shale gas and shale oil reserves, today's biggest energy exporters, from Russia to Saudi Arabia, will inevitably lose some of their control over these markets. (See also my recent presentation: Bubbles, Supercycles and the Next Three Big Energy Stories, posted on 15th April and also in the 'Presentations' section shown upper left.)

The moderate spike in energy prices which took Brent crude to a high of $127.02 on 14th April, plus Japan's earthquake / tsunami and related supply problems, will slow GDP growth somewhat among oil-importing countries during at least 2Q and probably also 3Q 2011. This is reflected by additional ranging, choppy activity for most stock market indices.

However, an additional spike in energy prices would probably be required to jeopardise upward scope for many equity indices envisaged by Fullermoney for 2H 2011. This risk is higher than we would like because the price charts have yet to produce clear evidence of medium-term peaks for crude oil.