There is no doubt that we are entering uncharted territory when it comes to the explosive run up in oil prices.
While the oil shocks of the 1970’s lead to a drop in world economic growth, we will no doubt experience a similar fate.
Further complicating the economic outlook is the pressure on the economy from the credit crunch and the still many unknowns in a post Bear Stearns financial environment.
What is causing these historically high oil prices? Are the speculators behind it all? Is the Organization of Petroleum Exporting Countries or OPEC the “usual” suspect here?
The world oil market is not the same as during the 1970’s. We have moved from a physical market to a global financial market where everyone is taking positions – short and long – on oil.
It has become an investment vehicle as any other with a number of firms specializing in it. A number of the investors who buy or sell oil now do not want to ever see a barrel of the black gold. Their only interest is the gain they could make should the market move in the “right” direction.
These investors are interested in what are called “paper barrels” while the refineries and other end users need the actual physical product.
They both bid the price up or down based on market fundamentals. The shift of the world oil markets into a global financial market has increased the number of players who are all sensitive to any change in market fundamentals or news that could affect the market and thus the volatility that we are experiencing lately.
This does not mean, however, that the prices that we are experiencing are somehow wrong or artificial. These reflect the basic fundamentals of supply and demand.
Despite all of this, there is a temptation to find a culprit whoever it is from speculators to the OPEC cartels.
Contrary to what some politicians on both sides of the isle may wish to say, speculators are not behind either the run up in oil prices or some grand scheme to defraud or gouge US consumers.
A look at the evidence shows that this is not the case. As The Financial Times has already reported, refineries are paying higher oil prices for light crude, much higher that what the prices that are posted in the oil futures market.
This clearly proves that speculators cannot possibly be behind the latest run up oil prices. As to OPEC, it does what all cartels do. It tries to limit the supply so that it can get the highest price it can for the one and only commodity it has to sell.
While OPEC controls about 40% of the world oil production, the remaining 60% is still outside of its control.
Uncertainty and the potential for instability in the OPEC producing nations add to an already nervous market which helps boost oil prices.
This is made worse by a tight market with not much spare production capacity to go around and a demand that sees no end in growth.
Complicating the demand side of the market are the subsidies for oil use in Asia and particularly in China and India, two countries that account for a substantial amount of the increase in global oil demand.
The issue of gasoline subsidies in Asia in particular was discussed this week during the G8 meeting in Japan as posing a major problem for the continued run up in oil prices.
However, it is unlikely that either China or India will do much about these anytime soon. On the U.S. side, we consume 24% of world oil consumption everyday but produce a mere 8%.
Alternatives will not come to the rescue soon enough and talk about drilling in Alaska is not a long term solution either unless we seriously address the demand side of the market.
U.S. consumers are already responding to high oil prices but that will take time. In the end, as bad as these high oil prices are, it will be the only thing- short of gasoline taxes – that will address our addiction to oil and curb our dependence on foreign oil.
Better yet, it gives us the incentive to find alternatives and truly work towards a U.S. energy policy that makes sense.
Mohammed Akacem is a professor of economics at Metropolitan State College of Denver.
