Tuesday, July 22, 2008

Oil Prices: Supply and Demand? Some Questions!

On July 11, 2008, crude oil prices hit a high of over $147 a barrel. Today, crude oil prices were hovering at about $127 a barrel. If the price of crude oil is truly determined by supply and demand, we suddenly had a significant drop-off in demand. The belief in the supply and demand theory has taken a bit of a hit as crude oil prices have dropped over $20 in 11 days. We heard about the Enron loophole and crude oil speculation was driving up the prices much as 30% or more. Then the "other" experts told us that the price of oil wasn't a result of speculation but a result of supply and demand. Chairman of the Federal Reserve Ben Bernanke testimony before the Senate committee supported the notion that the price of crude oil was a result of supply and demand. So much for credibility.

It is likely that "some" degree of speculation pushed the price of crude oil to its record heights. Once the price began to back off, the owners of crude oil contracts (we don't dare say speculators) began to sell off their contracts in fear that the price would soon begin to decline. Once a few people sell off, then a few more people sell off, and the next thing that happens is a "correction." It remains to be seen how much more the price of crude oil declines in the coming days and weeks.

If I were an owner of crude oil contracts I would be a little nervous now. There is no doubt that supplies of crude oil worldwide have been under pressure. But for the short term, and probably for the intermediate term, crude oil prices will remain high. However, in the not-too-distant future are factors such as T. Boone Pickens multibillion-dollar investment in wind power and others looking to make money in alternative energy could have more of an impact on the long-term price of crude oil then we had been led to believe. Also, the recent trend towards the manufacture and purchase of more fuel-efficient cars can have an impact on the price of oil. If Americans persist in this trend so-called speculation in crude oil prices might become less lucrative.


Dana said...

What I find most disturbing is that when oil prices increase $5/barrel, we see a $0.05/gallon jump in fuel prices, but since oil prices have decreased $20/barrel, I've only seen fuel prices decrease by $0.10/gallon. Hmmmm ....

Rob Miller, Ph.D. said...

Sorry dude. Supply and demand rule.

If you and I privately agreed to wager on whether oil prices would be up or down in the next week, it would have no effect on the spot price of oil whatsoever. Neither do futures contracts.

Only if one can buy and store oil can it affect the spot price. As price rises, your incentive to sell increases because a competitive market will quickly guess the right price.

Oil prices dropped because consumption was down. Industrial production in China and India dropped in April. This was the first year in 30 years that vehicle-miles-traveled in the US dropped. But cars aren't the big consumer here - trucks, trains, and planes are, and they had massive cuts.

Dana is wrong too. Prices of individual inputs are not perfectly correlated to the price of outputs. The high prices of ethanol and a petroleum based additive for summer blends kept prices relatively high.

There is no such thing as price gouging in a competitive market and there is no evidence of collusion.

If you want to know why gasoline prices are so high, it's because of high oil demand by China and India, lack of refining capacity in the US, environmental regulations, and TAXES. State and federal revenues from gas taxes dwarf oil company profits.

The guilty party is having party in Denver right now. Take your argument there.