Posted on 06/07/2008 7:28:48 AM PDT by SeekAndFind
The price of crude oil has jumped as high as $135 lately, up from $87 in early February. The news encouraged some Wall Street analysts to suggest oil might approach $200 before long. In fact, that's quite impossible: The world economy can't handle current energy prices, much less a big increase.
Which in turn means that oil prices will fall.
Market analysts often claim oil prices are almost entirely determined by supply. Demand is said to be insensitive ("inelastic") to price. The standard example is that many Americans have to drive to work and most gas-guzzling SUVs will still be on the road even if the affluent few can trade theirs for a Prius. Whatever the price, we'll pay it.
This idea rests on two fallacies. The first is to exaggerate the United States' importance when it comes to ups and downs in worldwide oil demand. In fact, America is using no more oil than we did in 2004.
The second fallacy is to greatly exaggerate the importance of passenger cars in the United States. It's true that Americans are driving less and buying four-cylinder cars - but that's not where we should be looking for serious "demand destruction."
Two-thirds of petroleum in the United States is used for transportation - but half of the transportation sector's fuel flows into commercial trucks, trains, buses, airplanes and ships. As a result, only 44 percent of each barrel of oil is used to produce gasoline in this country, and some of that gasoline fuels business - delivery vans, landscapers' trucks, fishing boats, industrial and farm machinery, etc.
Most crude oil is used to produce diesel fuel for trucks, ships and trains, heavy fuel oil for industry, aviation fuel, asphalt, home heating oil, propane, wax, and innumerable petrochemical products ranging from detergents and drugs to synthetic fabrics and plastic.
In short, a huge share of crude oil is used to produce and distribute industrial products. That explains why the price of oil is extremely cyclical - that is, it tends to rise during economic booms and fall during contractions. It dropped 44 percent in the last recession (from November 2000 to November 2001), 48 percent from October 1990 to January 1992 - and 71 percent from July 1980 to July 1986.
Oil prices have a huge impact on producers' cost of production - profits and losses - not just on consumers' cost of living.
Firms that can't raise prices will find profit margins squeezed - and will have to cut back on production and jobs. Even if some producers of energy-intensive products can raise prices enough to cover higher energy costs, they'll nonetheless sell fewer of their products because of those higher prices. So they too will have to cut back on production and jobs.
Nine out of 10 previous postwar recessions began shortly after a big spike in the price of oil. Yet those recessions always slashed oil prices dramatically. People who have been predicting both a nasty US recession and $200 oil prices are contradicting themselves.
Recent news reports have expressed surprise that the US economy appears much stronger than the famously gloomy predictions at the start of the year. Indeed, the surprising endurance of US manufacturing and exports is one reason oil prices rose as long as they did.
But note that a US recession isn't required to bring down the price of oil. All that's needed is industrial stagnation or decline in many other countries.
In the United States and Britain, industrial production is nearly flat - only 0.2 percent higher than it was a year ago. In many other countries, however, industrial production has dropped over the past 12 months. It's down by 0.7 percent in Japan, 1.1 percent in Austria, 2.5 percent in Italy and Denmark, 2.9 percent in Canada, 5.4 percent in Greece, 5.7 percent in Singapore and 13.3 percent in Spain.
In April, industrial production also fell in India and China. Shrinking industry around the world shrinks demand for energy in general - and for oil in particular.
When the price of anything gets unbearably high, it discourages demand. The resulting drop in sales, in turn, causes inventories to pile up and the price to come down. That has proven true of overpriced houses - and it will likewise prove true of overpriced oil. Also of interest
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Alan Reynolds is a senior fellow with the Cato Institute and the author of Income and Wealth.
Does this mean gas prices are going to drop too?
Hopefully!
These myths get retold every time the price of oil shoots up. It hasn't happened, and it won't happen.
I think most extraction costs are no more than $60 a barrel. This looks like a bubble.
Ain't happened yet, and ain't gonna happen. The price is just going to go up and up, until we all have to park our vehciles and ride around in Chinese rickshaws pulled by illegal Mexicans.
In other words; Kill my children, rape my wife, but PLEASE spare me!
The Cato Institute is supposed to be a reputable think tank? If this article is a sample of what it produces, it sure isn't.
Two record jumps just after the obama confirmation.
Eventually we’ll decide oil and the price of oil is a matter of national security, and we’ll go take what we want. And while liberals who have been claiming that the current Iraq war is about oil (which it wasn’t).... they’ll finally get the real thing.
The price of a commodity is determined by the markets...not the cost to produce. Gold is a commodity whose price is much greater than the cost to mine it...same thing with diamonds.
The current oil situation is not a bubble...its real. In 1997 the world sent a message to oil producing entities when it drafted the Kyoto Protocol. That message was "we won't be needing more of your oil in a decade or so". Oil producing entities got the message and, for the last decade, have not invested much in new production. Now we have seen demand go up over the last decade...not down. Guess what??? That means oil prices will remain high until either more money is invested in oil production or demand reverses itself and drops precipitously. The only problem with demand that drops precipitously is that it manifests itself in recessions.
I wouldn't put this toward demand reduction as much as the price historically induced exploration with a lag between investment and coming to market that roughly corresponds to the duration of a recession. Then cheaper oil helps "fuel" the recovery.
What is different now is the degree to which the producing side has been restricted by regulation sponsored by major stockholders of the oil companies themselves with "charitable" donations to environmental groups. That's the dirty little secret I've been trying to get conservatives to understand for nearly seven years.
Rush Limbaugh = Pollyanna!!!
He only says that because he wants to defend Bush from Democrats who blame the GOP for high gas prices. Limbaugh needs to do some research about long term supply vs. demand.
Yes, and the Dems are going to keep it high because it feeds in to their ‘it’s the economy, stupid’ autumn campaign.
And the spineless Pubbies haven’t and won’t do much about it.
[This is the same pattern that has been playing since Nixon and the gas lines of the early 70s.]
When people predicted $75 a barrel oil, EVERYONE here laughed at them. When people predicted $100 a barrel oil, EVERYONE here laughed at them. When people predicted $150 a barrel oil, EVERYONE here laughed at them. Now people are predicting $200 a barrel the Cato institute is saying they are foolish.
A lot of people are looking foolish.
Its not the World Economy yesterday that "predicted" oil would hit $200, it was Bear Sterns. So that means that any half-assed market "expert" can say "$300 oil" and boom there goes the price. I would make a law that any company predicting of a commodity price without solid basis or proof, that does not come true in 30 days, should be fined! Bear Sterns jerked up the price over what they think will happen, not any solid proof! This crap results is market panic and gorging us at the pump.
I don’t think you can blame, solely , Kyoto. This looks more like margin traders with low interest rate gone wild to me.
If you like $4/gal, Thank Congress.
President Bush has been warning about this for 8 years and they defeated every sensible energy plan he proposed.
Pray for W and Our Troops
" ... The shortage of oil was the key to Japan's military situation. It was the main problem for those preparing for war, and, at the same time, the reason why the nation was moving toward war. For the Navy the supply of oil was critical; for the Army it was always a limiting factor. And none of the measures taken to curtail civilian consumption or manufacture substitutes ever gave Japan enough of this precious commodity to free it from restraint by the Dutch, the British, and the ... "
ΜΟΛΩΝ ΛΑΒE
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