Oil prices surged to a record high above $112 last week. The current crude prices are nearly 10 times the levels less than a decade ago. Crude oil prices behave much as any other commodity with wide price swings in times of shortage or oversupply. The crude oil price cycle may extend over several years responding to changes in demand as well as OPEC and non-OPEC supply. The impact of crude oil prices on growth in developing countries is thought to be significantly higher, because energy-intensive manufacturing generally accounts for a larger share of their GDP.

Since 2002, major oil producing countries have been investing in exploration and development. Furthermore, planned gross capacity additions from new projects in non-OPEC countries (including non-conventional sources) would add to supply.Oil-consuming countries have also started diversifying their fuel-mix by switching to alternative sources of energy like natural gas and renewables. The interplay of these forces can drive down the prices of crude oil from the current levels.

On the demand side, while consumption in the past has been driven by OECD countries, particularly the US, much of the current incremental demand is coming from emerging economies, particularly China and India, which contributed more than 40 per cent of the incremental global consumption during 2000-06. Global oil demand is expected to increase to 100 million barrels per day (mbpd) by 2015 as against 85.7 mbpd currently.While oil demand is projected to increase significantly, supply may struggle to keep pace. The production from the existing fields is declining by 4 per cent per annum which means that new capacity needs to be added every year just to offset the decline in existing production.

The depreciation of the US dollar and the worsening US economy are also held as major culprits for the price rise. The falling dollar coupled with the declining stock and credit markets also increases traders' interest in commodities such as oil,which further fuels price rise.Speculative investment by major hedge funds also seems to play a key role on oil price volatility.They are not liquidating their positions until clarity emerges on the dollar front.

While, one cannot rule out the possibility of the volatile crude prices from receding somewhat in the near future, driven maybe by a dip in global demand as a result of sustained economic downturn in the US, what does appear is that over the last few years, the equilibrium price of oil has shifted upwards and the volatility has increased significantly, leaving prices vulnerable to fluctuations even due to the slightest disruption in supplies (like the recent one of a cracked pipeline at Tennessee which cut supplies of more than 1 million barrels a day to the US) or changes in demand.