Saturday, June 21, 2008

The Price of Oil

It constantly amazes how fundamentally ignorant people are of the most basic tenets of economics - supply and demand - when it comes to oil.

The global price of a barrel of oil is in the range $130. Yes, this price sounds high, but the price is signally two different things to take place that will drop oil back down a long way.

The price has risen enough to start to reduce demand. At the moment there is a global demand of about 85 000 000 barrels of oil a day. Because of the unprecedented staggering economic global boom going on for the last seven or so years, the demand for natural resources has been huge. The appetite for oil has been huge and the ability to pump out the oil and refine it has not kept pace. This of course means the price has to rise.

Now we see a high price, though not as high for most of the world because the US has been deflating their dollar dramatically. Since Bush came to power, he has seemingly taken a deliberate course of action to reduce the value of their money by 1/3. The rest of the world is seeing rising oil prices but not as badly as the US has.

The higher price means people stop using the product through looking for alternatives or simply not doing something. The price signals are making all manner of businesses trying to figure out how to reduce their oil needs. We will still have planes flying people to Hawaii for holidays, they simply be newer planes that use less fuel and eventually ones that will use some other fuel. we already see the drop in demand in the US.

The reduction in demand would be faster if less governments interfered with the pricing of oil. Places such as China, Venezuela, Saudi Arabia and Cuba all have state control over oil and fuel prices. These countries are consuming more oil than they would otherwise because the governments are stopping the pain of high prices to hit businesses and consumers.

The Saudi lack of market pricing for oil and oil related products in their country (or Iran or other oil economies) short change their citizens because they do not get the revenues they could from the oil.

So. demand will begin to edge towards 80 000 000 barrels a day. Once there is a 5% excess capacity in oil production per day, the price per barrel will fall dramatically.

Demand is falling due to price signals but at the same time the price is driving a rise in supply.

As the price has risen, exploration has risen, new reserves have been found, new technologies have been developed to extract oil, and plans to pump out more oil has risen. Increases in supply take much longer to occur than changes in demand. The price needs to remain high for an extended period of time to have business invest the huge costs to increase the supply.

The increase in price has made the tar sands, and other heavy oil deposits, economical to develop. The sustained price of over $100 a barrel means investment in oil sands have taken off. Over a period of years the Alberta tar sands will be bringing online 10 000 000 barrels of oil a day. By 2015 global oil production will be around 100 000 000 barrels a day.

Ah, you say there is peak oil. No there is not. The tar sands in Alberta alone have enough reserves to now out rank Saudi Arabia and that is based on a price of oil lower than now and that there will be no improvement in technology. Peak oil is only an issue for people who have no fundamental understanding of economics.

Will oil reach $200 a barrel? Possibly, but only temporarily if it does. I would be willing to bet that we will see $75 oil before we see $200. I would put $1000 on that with anyone that wants to take the bet. I would further be willing to bet we will see $20 oil before we see $300 oil.

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