Posted by: Dirk | June 2, 2008

Quo vadis, oil price?

Despite the stupid grammatical construction in the title, this is a serious discussion of what people think about oil prices. Let’s take a look at three important publications and their expectations, and connect it to a recent article by James Hamilton.

The FT reports that:

US regulators on Thursday revealed a wide-ranging investigation into crude oil trading practices amid increasing Congressional concern over the role of speculators in record energy prices.

James Hamilton is at it as well: Understanding Crude Oil Prices. Here’s page 15:

Ultimately there are physical producers of crude oil and physical consumers of gasoline, and insofar as the activities of either has any response at all to the price, incentives for consumption would be reduced and incentives for production increased whenever the price of crude oil is driven up. For this reason, an ongoing speculative price bubble would have to result in continuous inventory accumulation, or else be ratified by cuts in production. The former is clearly unsustainable, and if it is the latter, one might make the case that the supply cuts rather than the speculation itself has been the ultimate cause of the price increase.

Paul Krugman at the NY Times writes about the Oil Nonbubble, answering to Hamilton:

The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

But it hasn’t happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth.

The Economist reports that if it’s not speculation, then at least in the short and medium-run high prices are to stay:

In the short run, neither demand for nor supply of oil is very elastic. It takes time for people to replace their old guzzlers with more fuel-efficient cars, or to switch to jobs with shorter commutes, or to move closer to public transport. By the same token, it can take ten years or more to develop an oilfield after its discovery—and that does not include the time firms need to bolster their exploration units.

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