NPR's Market Place recently featured on an economist who said gas prices don't follow any rational economic pattern. Supply has nothing to do with demand, and vice-versa. Wonderful. TTAC contributor and former Car and Driver ME Stephan Wilkinson emailed me this morning on the same topic. "Opinions, of course, range all the way from simple supply-and-demand to Vast Right-Wing Conspiracy, with all sorts of goofball imaginings in between." Personally I like the Vast Right-Wing Conspiracy idea, but there's probably more to it than that. But how would I know? Wilkinson goes on, "There's an interesting piece in the new Conde Nast Portfolio, 'Crude Reporting,' on how bad a job simplistic journalists have been doing with the subject, at least in part because newsrooms are staffed by a generation of Reaganomics enthusiasts who believe that the market rules, whereas back in the old days, reporters were 'the redistribuionist children of the New Deal and the AFL-CIO.'" Well, if this is the same "generation of Reaganomics enthusiasts" who didn't once bother to ask Judith Miller if she was, you know, making shit up during our march to war, then a bit more is illuminated. Your thoughts?
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Same thing as the rest of the countries eco-problems.
“We the people…” have miss handled our finances, esp. with regards to credit to a ridiculous extent, devaluing our bucks.
Naturally we want to blame everyone and anyone else.
The economy is what we have made it.
So there.
Have a great weekend.
Bunter
I keep reading it’s because demand exceeds supply, but wouldn’t there be shortages? And why then do I read that “refineries are cutting back production to meet demand.” Well, then, they’re making demand exceed supply. And it’s all contrived.
John
I would say 50% supply and demand another 50% on the falling dollar.
An extra 2.4 billion people (i.e India and China) want to have a decent standard of living and to do that they need oil to ramp up development of infrastructure.
You can see this in all raw material prices, steel, cement, timber, platinium, Rhodium, etc. They’re all rising in price.
Also, if the dollar carries on falling and the Euro carries on appreciating, then it’ll only accelerate the switch to trading in euros rather than dollars. Which will do the United States’ economy no favours and could have effects all around the world.
The point is this, there are new boys to international development and they don’t intend on going anywhere soon…..!
It’s not a conspiracy, but it’s not exactly supply and demand, either.
Speculators are drawn to oil by war jitters (the unexpected political snafu might create supply shortages that don’t exist yet) and China (continued growth might create supply shortages that don’t exist yet).
Prices are also high due to the collapse of the dollar. That’s a byproduct of the war as well, as the markets don’t like to see the US stuck in a political quagmire, plus budget deficits are not good for inspiring confidence in the greenback. A strong dollar would lower oil prices.
Speculators also like oil and other commodities because returns on other investments are less attractive. With real estate tanking, the stock markets seesawing, and interest rates low, there isn’t much else to invest in. Improving the return on other investments would make oil less attractive.
Oil makes an easy investment because the cost of entry is so low. Traders basically put up about $10 per barrel for a futures contract, no matter what the price of oil is. They don’t really care how much they pay per barrel — no matter what the price is, they put out the same amount of money. They are betting on the price direction, not the price itself, so the actual price makes no difference to them.
Electronic trading also doesn’t help. It is much easier to move large amounts of capital than it used to be, which creates more volatility in the markets. Markets change more quickly and sharply than they did before.
This bubble should pop, particularly if the US ends the Iraq war, it’s just a matter of when and how long it takes. A global recession should put downward pressure on oil prices, because consumption declines when the economy is weak.
Supplies match demand, inventory levels are consistent and reserves are staying level, so there is no supply and demand problem today. Maybe there will be a peak oil problem in the future, but the numbers don’t indicate that the problem exists today.
Demand and supply aren’t numbers – they are curves. That’s why you don’t see shortages (unless price isn’t allowed to float).
Demand and supply aren’t numbers
Sure they are. Consumption and supplies are commonly measured in barrels per day.
We had shortages during the 70’s — there were gas lines and rationing, and new supplies and stocks were not sufficient to meet the demand. The OPEC cartel rationed supply, and was able to restrict availability for a time.
You don’t see any of those today.
weak dollar, china, india.
hodgepodge of other things, commodity traders, mid-east instability (see commodity traders), etc…
Pch101, let me ask you a question:
If speculators affect the supply and demand balance, where do they store the extra oil?
They need to suck away some supply so that it would not reach thouse who actually burns oil. Or, if you look the other way around, they need to create additional demand on top on the demand of the oil burners.
The pure play refinery companies are not doing so well either: check their Q2 reports and stock prices. I see two main reasons for the gas prices:
1) Supply and demand 2) Market manipulation by the oil companies that also own refineries.
If speculators affect the supply and demand balance, where do they store the extra oil?
There’s no need to store anything. Speculators don’t take delivery of the oil.
They need to suck away some supply so that it would not reach thouse who actually burns oil.
No they don’t. They are betting on supplies that don’t even yet exist — it is a “future” quantity that is probably sitting in the ground at the time that the contract is written.
When the contract settles, it is a financial exchange that does not involve oil at all. From an investment standpoint, it’s numbers on a page.
I think PCH nailed it – I’ll add a little emphasis on the budget part of it – we all like to pay as little in taxes as we can but want more of our government. As it stands a business or a household can’t stand forever when they pay out more than they take in. Our dollar does weaken anytime our federal budget is out of whack (like it is now).
Add in the Iraq and Afghanistan issues and the current administration pissing off a fair portion of the rest of the world and our dollar is in the toilet. It’s going to take a lot of work (and time) to reverse the damage that has been done.
There’s no need to store anything. Speculators don’t take delivery of the oil.
So, speculators do not affect physical supply and demand. Right?
So, speculators do not affect physical supply and demand.
Speculators affect the price. By bidding up the price in the futures market, it necessarily impacts the price in the spot market, until the bubble pops and supply and demand returns to serving as the primary price driver.
During economic bubbles, supply and demand aren’t the only drivers of price. Despite the claims of the oil bulls, hoarding is not essential for prices to be impacted. Which is the point of this discussion.
Of course price is determined by supply and demand. You just need to understand what is meant by “supply” and what is meant by “demand”. Part of it is the momentary supply and demand for oil futures contracts. In particular the term “demand” incorporates a lot of things, influenced by fear and psychology. Demand often is not synonymous with “amount consumed”.
Anyway the idea that the mainstream media is staffed by a bunch of Reaganite supply-siders is ludicrous.
IMO
Yes it is true that supply/demand effects on price has not been repealed
However
Except at the margins the current demand for petroleum products is fairly inelastic. In the short to intermediate term modern society cannot function without significant amounts of petrochemical products.
If I were a producer (or cartel of producers) I would control supply to raise the prices until I saw my income decline below my comfort level.
For example: 10 units at $100/unit is better for the producer than 20 units at $50/unit. Both yield $1000 income but less resource delpletion and overhead to produce and deliver 10 units.
And if you only need $500 income then 5 units at $100/unit might suit you as a supplier.
Perhaps that is what we see going on. Certainly producers and suppliers have had an opportunity to see what the “market will bear”.
It is only a short term advantage to the producers however since inflation and political disruption (drill here, drill now) will eventually result in a correction. Probably sooner rather than later since the more responsible producers will not want to push their advantage to the point it provokes a violent reaction.
Part of it is the momentary supply and demand for oil futures contracts. In particular the term “demand” incorporates a lot of things, influenced by fear and psychology. Demand often is not synonymous with “amount consumed”.
Exactly. Typically, the oil futures market is dominated by hedgers, who do care about the price because they ultimately use it.
These days, the futures market is dominated by speculators, who are indifferent to price and only care about the price movement.
The fact that they don’t take delivery is precisely the problem. The speculator doesn’t have to cope with the impact of the per-barrel price. A $10 movement is a $10 movement, regardless of the actual starting point.
Oil’s volatility makes this more exciting. When oil moved a few cents per barrel on a given day, it wasn’t that profitable. With prices jumping around as they are now, it is possible to make a lot of money on a relatively small investment.
You can’t fault the funds for trying to capitalize on this. But that doesn’t mean that we should just sit there and watch them bleed us to death in the process.
Oil’s volatility makes this more exciting. When oil moved a few cents per barrel on a given day, it wasn’t that profitable. With prices jumping around as they are now, it is possible to make a lot of money on a relatively small investment.
Cannot agree more! The volatility of the oil price is influenced by the speculators.
But I’m still not convinced about the effect of speculators on the oil price trend.
The volatility of the oil price is influenced by the speculators.
But I’m still not convinced about the effect of speculators on the oil price trend.
The volatility increases demand for oil investments, which makes the oil investments more expensive than they used to be.
We just saw this occur with real estate. The promise of returns created demand for investments, which made the investments more expensive. Buyers became less concerned with price, and simply assumed that the price would go up, which encouraged them to buy based upon expectations of price change, not the price itself. Just so long as they had the ability to get into the deal, they didn’t really care about the actual cost.
Volatility tends to push prices upward, because investment demand is what creates the volatility in the first place. That’s why bubbles deflate pretty quickly — once the party is over, the speculators flee like rats from a ship, hoping to find another place to play.
Another thing to mention…”demand exceeds supply” or “supply exceeds demand” is not an accurate statement from an economics perspective, unless you add “at the given price” to the end.
If there is a shortage of something, then by definition the price is too low, and vice versa if there is an excess of supply. That is, the price will either go up or down until equilibrium is achieved (demand = supply).
And as previously mentioned, all the various causes thrown out (speculators, value of the dollar, war in Iraq) are factors of supply and demand. So it all still fits perfectly well within the supply & demand model.
…on how bad a job simplistic journalists have been doing with the subject, at least in part because newsrooms are staffed by a generation of Reaganomics enthusiasts…
I thought I detected something stinky when I read this. I call foul BS on this statement. It generalizes newsrooms as being conservative, when no such thing is true. If it had mentioned the newsrooms of Investors Business Daily or the Washington Times, I would have let it pass.
Dishonest reporting and not serving the customers’ needs is exactly the reason the major dailes are laying people off faster than the automotive industry!
Thanks, redrum, for continuing to remind posters of the price-setting functions of supply and demand.
All the conspiracy theories break down on closer analysis. That “vast right wing conspiracy” Jonny likes to blame? Hey, right-wingers usually advocate policies that tend to make oil cheaper! Lefties, in contrast, usually favor measures that constrict supply. And what is this obsession with the “Iraq war” as the cause and solution of oil problems? Oil prices have been going up (and down) for a century. A more stable middle east, which is one of the goals of all on our side, would reduce uncertainty about supply disruptions. Anyway, ending the war isn’t up to the US unless capitulation is acceptable. It’s like saying in 1944, “End the Belgium War.” Leaving Iraq would not make Iran’s mad ayatollahs friendlier to us.
As for speculators, we should recall that futures contracts are bets on what’s not happened yet.
Buyers think prices will go up; sellers think they’ll go down. The actual price when a contract ends determines who guessed correctly.
I don’t see what the big deal is. Europe and the rest of the world have been dealing with $5.00-8.00 gasoline for a decade or more now. So now we’re catching up.
We’re supposed to be this big strong rich economy…well then why is everyone bitching and moaning about it? It’s hard to believe AMERICANS can’t stomach $4.50 gasoline if we’re such a rich and powerful country.
Everyone has to stop whining and just suck it up!
So, the consensus seems to be that various factors are causing volatility in the futures market, thereby bumping up the price in the spot market. The buble will eventually burst, and prices will come down. Anyone care to guess the price a year from now? (What if it was $3.75/gal a year from now? That would seem like a bargain, but it wasn’t that long ago we were all bitching about $3.75 being too high)
Long term trends are more important than the short term volatility. We don’t actually know what the supply will be in the future (we know its a finite resource, but that doesn’t mean supply can’t be increased, short term). What we do know, or can be reasonably certain of, is that supply will continue to grow – probably rapidly. The Chinese and Indians havn’t even begun to use oil at the rate of Europeans or Americans.
“Y’all” do what you like, but I’m not buying a V8.
Um, $145 barrels of oil?
Frankly, it’s easy. We just overcomplicate it.
It is the expectation of future demand exceeding future supply exacerbated by the flight into futures commodity trading because of the devaluation of the dollar and collapse of the non-traditional, high-return financial investment options that started this mess (ie – all those asset backed toilet paper rolls that were actually high-risk, variable-interest mortgages).
There you go. One sentence. The reason oil is down so much this week is the increasingly gloomy outlook on world oil consumption growth (due to slowing major economies) and the sharp rise in oil and gasoline inventories. What happens if demand weakens and there aren’t actually supply disruptions? That’s right. The price comes back down because it’s no longer as “safe” an investment. What’s becoming troublesome is if you are an institution, you may be trying to hedge the downturn through oil futures, but if you collapse the economy, you will be even worse off. So, there is some nervousness about how much higher oil prices can be speculated up before it backlashes on those investors through a glut in supply due to falling demand. I would suspect that we are in the $120-$140 range more or less until the fall when there will likely be significant taper barring some attack out of Israel.
With slowdowns in Europe predicted and China’s growth a bit crimped with the loosening of government price controls, I would bet we will be hard pressed to reach these oil prices next year – again, barring significant geopolitical instability.
Other than demand and supply is ICE futures trading in London. InterContinental Exchange owned by a US firm in Atlanta. About 30 percent of USA oil futures are through ICE. Until a few weeks ago beyond Federal securities regulation. Now by request of US, GB has imposed same reporting requirements. Congressional diversionary fear mongering is speculators. No factual information but good political propaganda.
“Belief” is that oil futures are being traded without economic substance like IRS Wash Sales regulations. More important I believe is the miniscule 10 percent margin requirement. High rollers, many USA, with millions to gamble at very high leverage. Recent drop from $145 crude price likely due to speculator fear of being caught holding the liability. Hope so.
Two things: the collapse of the U.S. dollar, and supply and demand, such as like gold and diamonds, the people who take it from the ground are the same people who control how much is on the market at any one time. So whether demand is increasing, as when China and India are “demanding” more oil, or when demand is decreasing, there is always just enough on the market to ensure the highest price possible. Currently, demand is higher than normal, and so are prices. Then, figure in the fact that the dollar is worth less every day, and it takes more dollars to buy a gallon of gas or diesel.
As for speculators, we should recall that futures contracts are bets on what’s not happened yet.
Speculators have no more effect on oil prices than betting on the result of a sport game affects the outcome.
Q: Why is the price of iron ore (no speculation allowed) double of what it was a year ago? Can’t be demand, can it?
Supplies match demand…
You forgot to add: … at a going rate of $130/bbl.
We had shortages during the 70’s — there were gas lines and rationing, and new supplies and stocks were not sufficient to meet the demand. The OPEC cartel rationed supply, and was able to restrict availability for a time.
Correction: Shortages resulted when the clever Mr. Nixon thought he’d just regulate prices and fix problems with the heavy hand of government. Without price regulation there is no shortage. It’s just a question of the price where supply meets demand.
Market manipulation by the oil companies that also own refineries.
Congress has investigated the oil industry numerous times, and came up empty every time. But don’t take my word. As we speak the SEC is at it again. Reports of no manipulation will surface any day now…
A global recession should put downward pressure on oil prices, because consumption declines when the economy is weak.
Well, at leat you got one right. Personally, I’d rather have a strong economy and expensive oil, than the global economy in the tank with cheap oil. But that’s just my preference.
So whether demand is increasing, as when China and India are “demanding” more oil, or when demand is decreasing, there is always just enough on the market to ensure the highest price possible.
So, Scarey, where were these all-powerful control freaks about 10 years ago, when oil was trading below $15/bbl? Or are you suggesting that they need a Republican in the White House to pull of their schemes? Democrats in control of the House, perhaps?
Every voter would love to know…
Answer: The disaster that is the US Dollar. Period.
That disaster was caused by absurd economic policies by our President and Congress, who have cut taxes, and increased spending, especially “war spending”. We are pouring our nation’s capital and standing into the sand of the Middle East and getting NOTHING in return.
Oil prices are in US Dollars. The US Dollar continues to circle the bowl.
–chuck
Engineer- ten years ago, China and India’s economies were just starting to expand. After a decade or more of expanding economies, the effect on the workers is now seen in that they are starting to buy cars instead of bicycling to work. Also, more factories are opening every week, and all this bodes for high demand for oil. Not to mention consumer goods (plastics) and medicines, which also derive from oil. Whether Donkeys or Elephants are in charge here seems to make no difference.
Engineer: Speculators have no more effect on oil prices than betting on the result of a sport game affects the outcome.
Well, what would the effect be if the players in the game were making the bets?
Speculators do have an effect on prices of futures, which then has an effect on the price of the commodity.
The weak dollar, rising commodities all around, and predictable growth demand for oil combine to make rising oil prices a sure bet.
(One thing I don’t agree with PCH on. Speculators DO have an option to take delivery, and they can rent holding space in Oklahoma, at least as I understand it. It may be different exchanges or types of contracts, or just an option).
So, let’s say you are a speculator who knows the game. You see signs of a weak dollar (partly driven by high oil prices resulting from supply and demand, but also for other reasons). You see world demand for oil growing greatly (China and India). You see empty storage facilities for oil because supply is relatively low.
Now, you can bet that oil will go higher, and if it doesn’t just store it, or rebuy more contracts and keep playing. You see the odds are stacked heavily in your favor so you keep betting higher and higher and so do your peers.
You know that if the price dips there are lots of players who will simply slow delivery by slowing up tankers, or putting oil in storage to see if they can’t sell it higher in a few days. Supply vs. Demand is so tight that you and guys like you can be fairly sure of a small downside. If there is a big slide in price, enough players will simply hold on to oil driving the price back up.
OTOH, any disruption will spike the price (once again because supply and demand are so tight, and many buyers won’t reduce consumption quickly).
Now, if I am right, what you have is an ideal world for speculators BECAUSE of supply and demand issues as well as the weak dollar. No one has to do anything illegal. Their actions are all legal and rational. If the price moves down quickly, short term supply will react quickly driving it back up and preventing large losses.
The fix is easy. First, we start letting the capped wells off the coast of california start pumping again. Then we open up leases that look like they are the quickest to exploit in the eastern gulf and off both coasts. Instead of auctioning for highest bidder, we auction for fastest producer. The company who is willing to pay the biggest penalties for failing to produce in a short time gets the lease. Or some similar scheme (Somehow, we find a mechanism that gets the oil flowing faster.) We could even use the strategic reserves as a cushion to speed things up (Let’s say we know that in six months we will get 50k barrels a day from the eastern gulf. We could then look at some swaps that would reduce the reserves a reasonable amount by swapping them with oil we have a high confidence we can get out in a certain time). The big advantage to using the reserve is you let the Speaker save face.
When we show political resolve and a bit of sense the combination with recently demonstrated demand reduction will make the market more robust to spikes and more risky for speculators. They will stop driving up the price.
The Saudi’s are already scared that the current price is going to cause us to start drilling. That is why they are pumping as fast as they can to get the price down. The last thing they want to see is us drilling everywhere we can. However, we don’t have to really drill everywhere, just show the resolve to drill more if the price gets out of line.
The real winner here is that if you drive the price low enough, fast enough, you can break some of the SOB’s like Chavez. That can lead to longer term stability.
Landcrusher: Speculators DO have an option to take delivery,
Naturally. However, only a microscopic fraction of all contracts actually cause real oil to change hands. I think it’s in the 1-2% range.
Everything is, by definition, speculation.
The Saudi’s are already scared that the current price is going to cause us to start drilling.
Somewhere, probably in some high tower in Dubai, some group of Saudi’s are laughing themselves sick at the idea the US can drill itself into any kind of meaningful oil independence.
Actually, that isn’t really true anymore, since Canada is your #1 foreign supplier of oil. I doubt anyone in Calgary is quaking in their cowboy boots at the prospect of the US un-earthing enough oil to liberate itself from it’s imported oil addiction.
The truth needs to be front-and-center:
http://en.wikipedia.org/wiki/Oil_reserves#United_States
“With production of around 5 million barrels per day (790×103 m3/d) as of 2006, this represents about an 11 year supply of oil reserves at current rates of production.”
and
“If the United States had to supply its entire demand of 21 million barrels per day (3.3×106 m3/d) without resorting to foreign imports, existing US reserves would last only three years at the current rate of consumption.”
This is all simple arithmetic.
Even if you add in all the speculative, unproven, sources, the result isn’t much better. Oil shale is a possibility, but that hasn’t even risen to the level of being merely unproven at this point.
mdf,
Do you know what “reserves” actually means?
I thas nothing to do with China or supply /demand. Supply and demand works only for items that are substitutable. prices go up for items and services that are not replaceable and are first necessity. If you increase prices for substitutable item, people switch them and go for a cheaper choice. if there is no cheaper choice and it is not a luxury item but is an idespensable one, prices go up forever. Here we go- cheap candies, and superexpensive dental care, insurance, house rental.That is why governments of the countries, you should never ever let privatize indispensable industries- like utilities, medicine, and schooling. Imagine if you had a substitute for 4 bucks a gallon gas, the prices would be compelled to go down. Now they don`t have to, because people consume all fuel anyway. That`s why you have cheap mobile phone charges, because if prices go up you can always cut talking and switch operator. if oil is in cartels, there is no roundabout way. And governments are involved in cartels because they milk taxes from every pint of fuel they sell.
Stalin was unfortunately right, find one who benefits from it, and you will find the guilty one. Damn, he nailed it.
The USA’s dependence on OPEC is causing high fuel prices. The attached video from Dr. Robert Zubrin provides a way out of this dependence. In short, it’s about mandating a flex fuel standard for new cars sold in the U.S. and opening trade to foreign alternative fuel producers.
http://tinyurl.com/54uaej
Landcrusher: Do you know what “reserves” actually means?
Even the most wildly optimistic estimates of future reserves in the USA — by a group that would love to sell you you guys lots of EOR equipment:
http://www.fossil.energy.gov/programs/oilgas/eor/Undeveloped_Domestic_Oil_Resources_Provi.html
only show a net factor of a little more than two (2) in reserve growth.
When you double (or even triple) a small number, you still have a small number.
But this is, sadly, less than half of the story.
Even if you manage to boost your reserves by a factor of 10, using Magic Space Alien Oil Recovery Technology (MSAORT), you will be unable to increase your production by the same factor. And let’s face it: even if you could, it would just reduce the depletion time to the currently small number it is today.
I remember when the4 blame was put on Katrina, and as soon as that pumping was restarted, all would be well. Or was that because of weapons of mass destruction? i must be confusing my boogeyman.
on a related topic, i would like to buy ethanol free gas in philadelphia and/or south jersey. can it be bought?
It’s geology that is causing high fuel prices. Unlike iron, copper or other metals when oil comes out of the ground it is consumed. There is no such thing as scrap oil.
There is limited amount of the stuff in the ground and we have found most of it. It is getting harder and harder to find and old wells are dropping in production. New ones coming on stream can’t make up for the decline in the old ones.
This is Peak Oil that no one dares call it’s name.
It is a fact. There can be no infinite consumption of a finite substance. God does not put new oil in the ground as we pump out the old.
Once oil is burnt it is gone and there ain’t no more.
I follow Peak Oil developments at http://www.theoildrum.com as closely as I follow the Death Watches and other posts here. If you want to know what’s going on with oil visit once in a while. It’s very interesting.
I see oil and gas being apparently high for two reasons. First, thanks to the Federal Reserve, the PE$O (formerly known as the dollar) is worth only about $0.37 based on today’s price of gold. Second, speculators are betting that Iran will be attacked in the next few months by the US and/or Israel.
And what is this obsession with the “Iraq war” as the cause and solution of oil problems?
For one, it creates uncertainty, which leads to volatility and catalyst for speculation. Markets don’t like uncertainty, and prices tend to become more volatile because of uncertainty. Stability is good for markets; doubt is not, and creates more reasons for speculators to speculate.
For another, the war is expensive. The value of the dollar is based upon the “full faith and credit” of the US government, something which begins to decline in the eyes of the world when the US becomes impotent politically with no apparent solution (as has been the case with Iraq) and when the budget deficit is climbing.
The war is the equivalent of your FICO credit score falling. If you max out your credit cards and get your cars repossessed, the credit world loses faith in you and will demand higher returns from you than they would from others in better straits.
For you as an individual, you’d have to pay a higher interest rate; however, since the US has force fed a low base US interest rate into the system, their alternative is to demand more of our dollars. So the dollar has tanked.
This is not unprecedented. The dollar also tanked during the depths of the Vietnam War, which provides a strong parallel to what we see today. It also helped to fuel a massive inflation which was worse than the one we are having now. Only by withdrawing from Vietnam and popping the 70’s oil bubble was the US able to create the basis for a recovery in the 80’s.
We should also learn from Britain, for whom the cost of war was so high that they suffered permanently from it.
Until the 1930’s, the British pound was the world’s reserve currency as the dollar is today. After years of costly empire building that it could no longer afford, what ultimately pushed the pound off of its perch was the huge cost that it suffered from World War I, which was large enough to permanently push the British economy into an inferior status. The pound never recovered, and even today, has an exchange rate with the dollar that is 40% of what it did prior to WWII.
Unfortunately, the US experience with WWII left Americans with the incorrect belief that wars are good for the economy. WWII was an exception; wars are almost always bad for the economy, because they put governments into debt.
Without the Iraq war, the US would look stronger and would have a lower budget deficit, which could only help the dollar. There are plenty of historical precedents that make it clear that losing a war is a good way to compromise the value of a currency.
This is Peak Oil that no one dares call it’s name.
In 2003, before prices began to leap, known oil reserves were 1,213 billion barrels.
In 2007, reserves had increased to 1,317 billion barrels.
In 2003, global consumption was about 79.6 million barrels per day. In 2007, it was 85.4 million barrels per day.
Do the math, and you can see that the increase in reserves kept pace with the increase in world oil demand. So much for peak oil.
The price of wheat has tripled in the last few years, despite the fact that supplies have increased more quickly than demand. Guess we must be hitting Peak Wheat, too.
As long as we run huge trade deficits and the current loose monetary policy the market will attempt to correct the trade and cash flow imbalances, and so I think the dollar will continue falling, and as long as the dollar is falling the price of oil will keep rising. I suspect we could still have sub-$3 gas if not for cheap dollar. We import 120B worth of goods more from China then what we sell to them. The markets are automatically trying to rebalance things so that we either import less of other goods (e.g.) oil or borrow money from abroad or sell our assets to foreigners (and all three are happening right now). And of course, the next problem is the rapidly increasing demand.
By the way, given the comments I see on various boards on the internet, it is clear that 95% of population has not taken an economics 101 course in college and does not really know what “demand and supply” mean as well as the underlying principles behind the downward sloping demand curve or the upward sloping supply curve.
Hint: the _quantity_ demanded or supplied on some market during some time period is _not_ the demand and supply, it’s just an equilibrium that represents a single point on both demand and supply schedules. It is totally feasible to have increasing demand, static supply curve, and have prices AND quantity supplied increase at the same time. Remember that the supply curve always points up, there will be no additional supply until the price increase as well.
Pch101,
When the prices on the futures market increase, this reflects the belief of all market participants, including the speculators, that the demand and supply at the future date will result in an equilibrium price that’s higher than today. The speculators certainly have the power to bid up the futures prices, even above the future equilibrium spot prices. However, they have little control over the current spot price other than the _downward_ pressure on the price.
Since most speculators don’t have capacity to store the actual product, they are forced sell their contract before the delivery date, thus providing liquidity to the market. If there was a bubble, and the futures prices were bid up above what the supply and demand equilibrium is, actual consumers of oil wouldn’t buy the entire stock of oil promised to be delivered on the date and this excess stock would have to be stored somewhere. Most speculators have a choice to sell at loss or some can try to gouge the market by not selling their oil on the spot market, thus restricting the supply and driving the spot price up. Since the oil inventories had been at their normal historic levels for years or below normal, the low or normal levels of inventories is the core of the argument that the spot price is not a result of “gouging” or “speculation”. In fact, to this day the academic economists are struggling to formulate and empirically verify a model of futures market manipulation that does not involve the manipulation of inventories or the restrictions of supply by the actual oil exporters (but the later case is not really a speculation, but a cartel tactic).
And what does the word “bubble” mean anyways? Bubble means that a product is being bought and sold at the price that’s above the discounted income or utility that this property will provide to the ultimate user, and most people simply buy and sell hoping that they will sell it at a higher price in future. For example, during the housing bubble in many areas the prices of houses were driven above the discounted value of money you can receive by say renting this house to people who will actually live in it. Same for the stock price bubbles. When there is a stock market bubble, the shares of a stock are sold for more than the present day discounted value of all future dividend payments of this share. Many trades simply buy because they hope the price will continue going up and they have no clue about the actual future dividend returns. On the oil market however, the spot price is being paid by the consumers who essentially either consumer the oil themselves, or manufacture a product that they also expect to sell ultimately to the end users. Therefore, since the consumers are actually paying the current price for oil/gas, this price reflects their current valuation for this product and so I just don’t see how we can’t have a bubble here if people are willingly buying the product to consume at the current prices.
it is clear that 95% of population has not taken an economics 101 course in college and does not really know what “demand and supply” mean
What’s also clear to me is that 95% of the population that took Econ 101 never bothered taking a follow-up course or six that could have taught them how to properly apply the lessons of the first course, instead of equipping them just enough information to be dangerous. Hence, the simplistic discussions of “supply and demand,” where they chanted as some sort of mantra as if to say that prices are always in equilibrium.
Speculative bubbles occur fairly often. The more leverage there is in a segment, the more of it tends to occur because the speculator can transfer much of the downside risk to others while keeping the upside for himself. Econ 101 would leave one to believe that bubbles can’t occur because prices always go to equilibrium, but the follow-up courses would illustrates that prices usually rotate around equilibrium and occasionally do become disconnected from fundamentals.
In this context, a normal market would yield a price for a good generated from a “supply” produced by a competing pool of producers and “demand” as determined by end-users of the product. The entrance of speculators into a market provides a form of liquidity, as new money enters not because of a desire to consume the good but for the chance to benefit from price movements.
That’s fine in small amounts, but as we just saw with the real estate bubble, can stimulate drastic unsustainable price increases as prices no longer relate to the underlying fundamentals of the good itself. The speculator is interested in price movement, not the intrinsic value of the good, and the added demand pressure created by the speculator pushes up the price.
The futures price drives the spot price, there is no meaningful real world separation between these two prices. Usually, that’s fine, because the hedgers who typically dominate the market ultimately have to live with the price and bid with a sense of the entire contract value, not just the margins that they wish to play.
At the moment, that is clearly not happening. The fact that consumers are radically changing their vehicle purchasing choices and business users such as airlines are dramatically changing their business models to address the price changes is a strong hint that the situation is in flux and is not stable.
The reason that oil markets behave as oddly as they do during bubble periods is because in the short run, demand is inelastic. It takes time for users to be able to take action in response to the price, which is to effectively add elasticity to demand.
A parabolic shaped price curve suggests a bubble. In Econ 102 (the course that more 101 students should have gone on to take), one would learn that dramatic short-term price movements not driven by demand fundamentals are not typically sustainable for prolonged periods.
Speculators are willing to pay higher prices and do, which makes things more expensive for everyone else. When they exit the market, prices collapse. That’s why some of you bought $200,000 houses that are currently worth $300,000 for $400,000. In the case of oil, nobody outside of OPEC will be sad to see the demise of a $130 price being paid for a $50-60 product.
Just about all theories here center around systems and processes. Why not go a little deeper and find the people who control these systems and processes. If the right people were harassed or *gasp* lynched, gas prices would drop real quick….
The extensive discussion on this thread reminds me of that old line about “if you laid all the economists end-to-end, they still wouldn’t reach agreement.” It’s been exhaustive and exhausting, and I’m moving on.
As for the comments on the “Iraq war” (I use quotes because we stopped fighting Iraq in 2003), it’s clear that different geopolitical philosophies are irreconcilable and it gains nothing to keep debating. I do agree that “There are plenty of historical precedents that make it clear that losing a war is a good way to compromise the value of a currency.” Which is why I’m so pleased that thee situation in Iraq has vastly improved since Petraeus took over (NYT, please take note). Winning is better than losing. Especially considering the nature and aims of our Islamofascistic enemy.
There is a lot of confusion here. Let me address just one question:
If supply and demand are the cause, why aren’t there shortages?
Answer: because in an ideal competitive market there will never be shortage. Commodity markets are not perfect, but are close enough to ideal that you will rarely see shortage.
Sellers want to advance their own interest, and as soon as supplies start to tight prices move up until things come into balance.
In other words, you will never have to stand in line to buy gas, there will always be as much as you want – **if** you have enough money. Go buy a Hummer, set tire pressure to 10 psi, drive like a maniac 100,000 miles per year – if you got the money, they got the gas. As Lenno says, crunch all you want, we’ll make more.
There is no single number for demand – there is a demand for each price, i.e. a curve. hypothetical Example: US might demand 140 billion gallons of gas at 2$/gallon, and maybe 130 billion at 4$/gallon. Likewise supply is not fixed, it is function of price. As we all should have learned in freshman econ, the intersection of the two curves is the market price.
In 70’s there were lines because it was not a free market – feds stepped in to limit price and regulate distribution. We could have 2 dollar gas tomorrow – you might be able to actually buy any though.
Beachfront property is Malibu is expensive, but there is no shortage. If you have the money (I don’t) and if you want to spend it, you could buy some no problem.
Many other commodities (steel, wheat, corn, tin, copper, trophy wives) have had similar or large price increases – **BUT** no shortages.
Markets work – if we let them.
PCH and I disagree on one other thing (actually a lot, but not most of this thread so far). The value of the US dollar is greatly increased by confidence in our military might and willingness to use it.
I believe that the infighting and lack of will demonstrated by us during the Iraq conflict has greatly reduced that confidence. PCH believes that confidence is eroded due to us over stretching our abilities leaving no power for another conflict. At any rate, we could continue to run deficits and do all sorts of economically stupid stuff until that confidence got eroded because gold or oil has no value to dead men. The dollar is better than either in a world crisis, because it’s assumed we will win.
If after the election, we are seen as strong because we don’t back down (whoever wins) then the dollar will start to recover. If the infighting and dovish behavior returns, the dollar will continue to sink because it doesn’t matter how much might you have if you are too soft to use it.
Also, still waiting for a good definition of “reserves” from anyone who wants to argue the US can’t produce enough to make a difference in the world price of oil.
If after the election, we are seen as strong because we don’t back down (whoever wins) then the dollar will start to recover.
If the markets believed that, the dollar would not have tanked as it has. Clearly, the markets are not impressed by the US’ achievements.
The markets are results oriented. Because the results are bad, they depress the price of the associated good.
The markets are neither anti-war nor pro-war. They are not ideological or concerned with Bush’s name calling of the evil axis or the shouts of imperialism from opponents. But they do want results and stability, and will pay accordingly.
Had the US won the war, the dollar would be doing wonderfully and we wouldn’t be having this discussion. If the US could wave a magic wand tomorrow and fix everything in Iraq to become a quiet occupier overseeing a peaceful government and flowing oil supplies that could help to cover the cost of the occupation, the markets would be very happy.
Since that victory doesn’t seem likely, we should be more pragmatic and sort out an alternative. The war has already been lost and is continually being lost, so at this point, the markets will respond positively only to victory or withdrawal — nobody likes the status quo. Since victory appears to be impossible, withdrawal is the only remaining viable option. It would take years for the US to recover, but that would form the foundation for recovery.
Markets work – if we let them.
We are letting the markets “work” right now. We can see from the results that left unchecked, markets produce the volatility and price disconnects of the sort that we have seen lately.
Last week, the price of oil dropped $10/barrel. For the sake of comparison, it was possible just a few years ago to buy an entire barrel of oil for just a bit more than $10/barrel.
Nobody who has looked at the numbers can possibly say that consumer demand for oil changed that much in three days. This unprecedented degree of volatility cannot be explained by consumer behavior, nor can it be explained by production, both of which were pretty much the same at the end of the week as they had been at the beginning of the week.
The history of economic bubbles is long, and they always end up with the same ending. To deny that bubbles occur would require avoiding history books — they obviously happen. Econ 101 doesn’t teach enough to explain them perhaps, but the reality is documented for anyone who wants to read it.
Landcrusher: Also, still waiting for a good definition of “reserves” from anyone who wants to argue the US can’t produce enough to make a difference in the world price of oil.
So you don’t want “oil independence”, being merely willing to settle for a “difference in the world price of oil”?
If so, what a low bar you set!
All you have to do is withdraw a portion of your own 5.something million barrels of oil per day from the market and watch the price rise.
You can also pull a Saudi Arabia and try to pump more per day of what little you have left. In a rational market, you’ll see the price go down.
You will find you will have a significantly harder time at the latter than the former though. You will work very hard to a modest change: the law of diminishing returns at work.
Neither of these depend on the definition of “reserves” either.
Flipping to a high bar, “oil independence”: since the USA is not anywhere near as endowed with oil as Saudi Arabia or Canada is, it’s safe to say, short of a colossal disaster, the USA will never be truly oil independent ever again. (Google up Einstein’s definition of insanity.)
For an achievable goal, I suggest a small notch down from “oil independence” to “energy independence”. Classic economic substitution, and fully supported by the laws of geology, and physics. Best of all, it would stick it just as hard to the KSA, OPEC, and even Canada.
Pch101
Are you saying that the equilibrium price that’s determined by a short-term demand was not motivated by economic fundamentals? Yes, the demand will change with time, which will put downward pressure on price, but for now what we get is indeed short term supply and demand interactions.
Please stop mentioning the housing bubble. “Economic Fundamentals” is what the end users are willing to pay for the end product. The housing market is different from the market for oil or say tomatoes. The present value of a share of stock or a house is the sum of all expected returns rendered during the asset’s lifetime, and asset’s lifetime is indeed very long time, and I can see that it is totally feasible that the current price of the asset will become decoupled from its discounted (to present day dollars) lifetime value. It is difficult to estimate the sum of all rental income or say the sum of all dividents you will receive because of the uncertainty that’s amplified by asset’s long lifespan. But when it comes to oil, investors or users don’t keep this asset forever. Ultimately it is bought to be consumed more or less immediately. If the consumers buy the quantity offered at the going prices, without leaving any significant shortages or surpluses, then this is indeed the current price that was set by the supply and demand. Consumers buy the current quantity of fuel at the current prices because they indeed value it this much right now. So, I don’t how the current prices of gas are not a result of supply and demand interactions.
Yes, there might be a bubble with respect to oil price to be delivered a year from now. You can argue that traders that claim that oil will be worth $200 very soon are living in a bubble, and are causing a bubble in the futures market. However, as far as I can tell, up to now the investors were bidding up the prices because they were predicting the future supply and demand equilibria correctly. Most of them made a whole lot of money instead of losing. If they bid up the price too much, then they would either lose money by selling it at a lower price or have to store the product, and there is no evidence of either one happening.
Moreover, I don’t believe that the long-term changes in the American demand for oil will also necessarily offset the increase in demand elsewhere. Only time will show. First, as far as I can see, the demand in countries like India, Russia, and China continues to grow. People become more affluent and realize they can own a car, even if gas is $5/g. It is feasible that their numbers will offset the demand reduction in the united states. Next, gas and related products are subsidized in many countries (certainly in most oil producing countries), and so the people in those countries don’t have to bear the high prices and continue to use as much gas and other oil products as before. I am very skeptical that we’re going to see cheap oil again without a major worldwide economic recession like there was one after the Asian financial crisis.
PCH,
We won’t ever resolve this disagreement. There really is no way to measure it in a controlled way. Most of what you said had nothing to do with the point, in my opinion.
The value of the dollar is like a stock. It contains a real value based on what you can get for it, but also a future value based on confidence that you will get more (or less) for it in the future.
The confidence has a lot to do with our military might AND our willingness to use it wisely and judiciously (or more accurately, others preceptions of those things).
We disagree on that, fine. If you want to see rabid inflation and a continued sinking dollar then all you have to do is let the rest of the world start believing we are a paper tiger. Under every reasonable theory of how wars begin, that will lead to a big one. Until we fight and win that one it will be really bad economically in this country. Sorry. That’s just how it is.
The continuation of the trade deficits and budget deficits cannot continue without world confidence in us being the biggest dog and the world’s police force. Most of our exports are easily stolen because they are intellectual property. So we are in double trouble without military prestige.
For good or bad (I believe good), we are the world’s leaders. If we want to give up that role, we sure as hell better get the books in better order first. Whoever becomes President, he better say the right things, make the right moves, and have support from congress. I don’t see any change in our reputation (barring something extreme) until after the election.
MDF,
Great, we can just skip it then.