Monday, 3 December 2007

The Price of Oil – It’s Politics

Yesterday Mr Unslicker drew our attention to the seemingly endless rise in commodity prices. If we look at oil, heretofore the driver of all energy prices, we are at the threshold of the $100 barrel – a doubling of the price (in $) since only February !

Sounds scary, and indeed it is. First, recognise just how extraordinarily high this is in terms of the fundamentals of supply and demand. A short post like this isn’t the place for much detail: but suffice to say it is estimated that at a sustained price of a ‘mere’ $80 per barrel, the world could physically produce at least 5 - 6 times as much oil as has been produced in the history of the planet to date. Even $40 would be enough to allow production of 2 times as much. No obvious shortage there.

Then we must consider what is causing this apparent suspension of the laws of supply and demand. A price spike is a price spike, but this is beyond a joke. The answer is of course the obvious one: the resources are increasingly in the hands of countries that do not permit full market access. And at these prices, many of them are in no imminent need of changing their ways.

Opinions will differ as to how outrageous this is: the average vendor of (say) software or pharmaceuticals has no intention of selling at cost-price either, if he can possibly avoid it. Western economies attempt to counter this tendency via competition policy, but not always with complete success (see, err, software and pharmaceuticals).

The laws of supply and demand, however, are not flouted indefinitely. The precise mechanisms by which they make themselves felt may be politically benign – for example, a spontaneous sharp correction in prices in the next year or two; or large-scale substitution of conventional oil with coal liquefaction.

But they may also include some uncomfortable outcomes: with hard times a’comin, neither China nor the West will long find it easy to live with $100 oil.

ND

15 comments:

Mark Wadsworth said...

How does $100 compare with previous spikes of 1970s or 1980s, on an inflation-adjusted basis? Or even better, if linked to average earnings?

Is there any reason to assume that this cartel won't break down, just like earlier ones?

Venezuala is going to hell in a bucket, they are going to have to turn the taps up a bit in a couple of years.

Nick Drew said...

Mark - it may not be unprecedented by some measures (although the international politics and economic consequences that accompanied both 1973 and 1979 were by no means palatable).

On the one hand, oil per se features proportionately less in developed economies these days. On the other, the cartel (+ Russia) hold an even greater % of production now than they did then: and oil now drives the price of both gas, and in many places electricity also. So the overall impact will be more than would seem at first.

In the long run, as you've gathered, I reckon supply & demand will work their magic (though turning up the taps isn't always as easy as you'd hope, what with the big shortage of engineers we've discussed before). In the short- and medium-term, strange things might happen.

Anonymous said...

You're not hinting at Denationalisation by Armed Force, are you?

At $100/bbl, it might indeed be cheaper than just paying up.

CityUnslicker said...

Will prices come down as the recession bites? I fear if not a nastier version 70's economy re-run.

Nick Drew said...

Dearime - it will probably have occurred to someone ...

Of its own volition, it is likely to go the way CU suggests, if people have the patience

but

the converse of this, is a certain Mr Владимир Владимирович Путин (whom we must congratulate on his recent electoral success), who is becoming quite enthusiastic about high prices and may not be at all chuffed to see action being taken to lower them. Although he is not an OPEC kinda fellow (he has no time for quotas, you understand), he may have some 'thoughts' of his own in this regard

Newmania said...

Thyats interesting there has been a lot of press recently abiut the end of Oil but from this pst it would seem that our local difficulties are of a different kind .

Incidentally , the pirce of Oil has a considerable impact on the Scottish nationalist case. I wonder what wiould happen if it wen down

Wolfie said...

Haven't you side stepped another major issue? That the dollar weakness is not only feeding the rise but with OPEC countries holding massive dollar reserves they are themselves in a panic mode to offset securitised losses? Perhaps with some producers moving to the Euro this might force a re-aligned stabilization? Those funny coloured notes are looking sexier by the day.

Nick Drew said...

Mr M - yep, no End of Oil in our lifetimes, it'll still be going strong whenever the next technology comes along.

(In the meantime I'm sure messrs Chavez and Путин will be happy to have Salmond join them around the cartel table)

Wolfie - massive question. Over the period 2003-7 where $ oil price has trebled the € price has 'only' doubled.

Any oil exporter who wants to be paid in (or convert their revenues to) € has been able to achieve this for several years now, since there has been compete liquidity in the oil and FX markets.

To the extent they are still holding $, we must therefore assume it's because they choose to do so - either a positive choice, or inertia/idleness,

OR that they are nervous of causing a landslide...

Wolfie said...

OR that they are nervous of causing a landslide...

Quite obviously, yes.

Anonymous said...

As soon as China reverts to a Time of the Warlords, the oil price will sink. Temporarily.

Anonymous said...

This is all to difficult for me - I am off down the Pub anyone coming?

Anonymous said...

Supply is limited by the lack of refinery capacity. There is plenty of crude, but not enough refined product. It seems that lack of the refined product has pushed up prices of the crude product on a speculative basis, perhaps on the mistaken belief that the shortage of the product is caused by crude shortages. This has been helped by years of inflation of the dollar - more dollars in circulation means inflation, and the inflation is moving out of shares and real estate and into commodities, oil being just one.

Nick Drew said...

Mutt - excellent idea, we must have an Xmas works outing: watch this space

anon - agreed: spare refining capacity has declined year-on-year since 1999 and existing capacity is increasingly wrongly configured for changing supply-demand patterns. Will need substantial investment (in a sector with traditionally poor margins) - and a lot of high-grade steel; which brings us to another problem ...

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