Oil Prices

There has been a lot written about causes of the recent increases in the price of oil, but much of it fails to make sense at even a basic level. Some writers blame the greed of the big oil companies, but oil companies always want to sell their product for the highest price possible, just as everyone else does. Yet, for much of the 1980’s and 1990’s oil sold for ten to twenty five dollars a barrel. If you believe oil companies can set the price of oil at will, you have to explain why they were so recently asleep at the wheel for nearly two decades of generally cheap oil.

The villains de jour are the speculators in the oil futures markets. Speculation can amplify trends, but it is not effective at creating them except in the very short run. There was an active futures market for oil in the 80’s and 90’s with traders just as smart and greedy as those we have today. However, they were unable to drive prices up to anything approaching today’s levels.

When we look for a cause for some new event, we need to look for something that is different from conditions in times when the event did not happen. Oil companies and speculators were just as greedy when oil was cheap as they are now. If they could have gotten higher prices for oil then, they would have. So simple common sense requires us to look for other causes.

The first and most obvious one is greater demand, particularly from Asia. More people in China, India, and other countries are becoming wealthy enough to afford motor vehicles and the fuel to power them. There are a lot more buyers in the oil market than there were ten years ago, and they are part of the cause.

Also, the geopolitical position of the United States has weakened in the last few years, due largely to the war in Iraq and other actions of the Bush administration. This may have emboldened some of the anti-American governments in OPEC to be more aggressive with the cartel’s policies on restricting supply. Governments in several producing countries have seized or taken more control of oil fields and facilities with the usual poor results for production, development, and effectiveness. In general the members of OPEC and some major non-OPEC producers such as Russia are more hostile to the United States and more narrow mindedly nationalistic in their behavior than they were a decade ago.

The Middle East seems to be headed toward a war between Israel and Iran and perhaps Syria. The market could be pricing in the consequences of such a war now. Some experts think that war fears are responsible for most of the price increases in 2008. It seems obvious that they are at least a partial cause.

The dollar has depreciated in the last eight years, particularly against the euro and gold, and in the last year or so the United States has seen its monetary inflation creating increased price inflation. These things have fueled the rise in oil prices. Since 2001 the price of oil in the strong euro has gone up far less than its price in the weakening dollar.

The government of the United States has had an utterly absurd set of policies on energy for years. Politicians have restricted or blocked access to domestic oil reserves including huge deposits of oil shale, stalled the development of nuclear energy, retarded the expansion of refining capacity, blocked construction of coal-fired power plants, and - to add goofy insult to significant injury – offered as a solution to the problem a ridiculous mandate to force people to burn corn liquor in their cars. None of this has been exactly productive.

I think all of these things are among the causes of high prices for oil. Possible partial solutions include stabilizing the currency and slowing monetary inflation, ending the war in Iraq as soon as possible without appearing defeated, removing restrictions on nuclear power and domestic oil, gas, and coal production and use, getting tougher with OPEC, and preventing both a nuclear-armed Iran and a war between Israel and Iran. Since few of these things seem likely, we may have to tough it out and muddle through, knowing that prices of commodities fluctuate and waiting for the eventual decline that should come sometime anyway, despite the efforts of politicians and regulators.