www.econbrowser.com/archives/2008/07/oil_prices_and.html
Main July 25, 2008 Oil prices and economic fundamentals Oil was selling for $123 a barrel on May 7, and that's where it closed this week. Sounds like a calm and rational market, except for the fact that just last week it was going for $145. CAPTION: Spot price of West Texas Intermediate in dollars per barrel.
gif Which price was right, $123, $145, or something else? Before you let anybody give you an answer to that question, try to get them to comment first on the following two facts.
gif Now, how could it be that China is burning 860,000 b/d more than it used to, but no more is being produced? Well, it could be that there are errors in the consumption or production numbers, and both will likely be revised. Or it could be that we're drawing down global inventories. But the most natural inference is that somebody else in the world must have been persuaded to reduce their consumption of oil between 2005 and 2007 to free the barrels now being used in China.
preliminary EIA estimates, petroleum consumption in the US, Japan, and those countries in Europe for which data are now available fell by 760,000 b/d between 2005 and 2007. Here's the framework I would propose for answering the question of how much the price of oil should have risen since 2005-- the price of oil needed to go up by whatever it took to persuade places like the US, Europe, and Japan to reduce their consumption by the amount that China, the newly industrialized countries, and oil-producing countries were increasing theirs. Somebody who claims to know that would need to have more confidence in their estimate of the price-elasticity of oil demand than I have in mine. But if your answer is that a much smaller price increase than the one we observed would have been sufficient to produce the requisite decline in quantity demanded, that would seem to imply that, since price went up by much more than you believe was needed to reduce demand, the quantity demanded must have fallen by much more than was called for. One place that might have been expected to show up is in the form of an accumulation of inventories. The black line in the figure below shows the average seasonal behavior of US crude oil inventories. The red line demonstrates that current inventories are if anything below normal. On what basis, then, could one insist that the quantity of oil consumed has fallen more than was necessary? CAPTION: US weekly crude oil ending stocks excluding SPR (thousand barrels).
gif OK, suppose you believed that the price increase we actually saw-- from $42/barrel in January 2005 to $96 in December 2007-- was just the right amount to accomplish the task of balancing global demand and supply for 2007.
is likely to come in higher than many of us had predicted earlier, meaning if you gave one answer for the correct price of oil in January, you should be giving a higher value for that number today.
If that occurs, it will bring a reduction in the quantity demanded from those areas even if the price begins to fall. Whatever the correct price of oil was two weeks ago, I think it's a lower value today.
delayed response of quantity demanded to the price increases already in place? If that proves to be substantial (and I'm of the opinion that it will), US petroleum consumption should continue to decline during 2008 even with no further price increases and no recession.
Won't that be enough to satisfy those new and thirsty Chinese vehicles? But don't forget, while you're doing these calculations, you'll need to meet Chinese demand for 2009, and 2010, and 2011....
project the current trend and tried to satisfy entirely by cuts in US consumption, would have us down to consuming zero barrels of oil in the United States in about 17 years. Is the price of oil today too high given the fundamentals? But one thing I'm sure that's too high is the confidence on the part of those who insist they know the answer.
from Outside The Beltway | OTB Yesterday the price of oil on world markets closed at $123 a barrel, just where it was at the beginning of May this year. Oil economist James Hamilton has an excellent post that suggests that the fundamentals of supply and demand may well be the major...
Via Mark Thoma, economist Jim Hamilton tackles that question here. Shorter Hamilton: if you think it's a bubble, what makes you so sure you know what the price should...
Resources to Inform from DiscussEconomics Blog *Updated July 26rd, 2008* Here is a list of resources online that are in the midst of the discussion regarding the role of speculators in driving the price of oil sky high. Let us know if we've forgotten some important / useful articles.
Tracked on July 26, 2008 09:09 AM Comments According to Bloomberg, over the past year, the price of oil has traded inversely to the US dollar 90% of the time (and I doubt that this is merely a coincidence). A higher oil price weakens the US dollar and vice versa which means DickF is correct that our debased dollar is driving inflation higher. What do you think would be most likely to finally break this inverse correlation between the price of oil and the US dollar? Posted by: Charlie Stromeyer Jr at July 25, 2008 05:43 PM "Is the price of oil today too high given the fundamentals? But one thing I'm sure that's too high is the confidence on the part of those who insist they know the answer." My friend and I are recent college graduates in radically different fields: English and Philosophy for him, and Economics, Accounting and Finance for me. In a conversation we had, he expressed his desire to teach English in Brazil and noted that he always would be employed because of the booming economy there. I replied that the country was heavily dependent upon commodities, and that many economists and financial experts believed the exponential increase in the price of commodities was something of a bubble (Negative real interest rates). Shrugging his shoulders, he then declared Brazil the perfect short (A concept I had explained to him earlier. But I hesitated again, telling him that many experts believed the prices were justified on firm foundation values! When he asked whether I believed it was a bubble or not, I told him I had no idea. I glad that has become somewhat of the rational position!
Kevin A at July 25, 2008 06:37 PM A question for the economic historians, among others-- Historically, developing countries have experienced wicked boom and bust cycles. Why should we expect present day China et al to be different? Using history as a guide, we should expect a ginormous contraction following the current boom. Or, is the Chinese central planner better able to control the boom/bust cycles relative to the late 19th/early 20th century market economy? The point is, a multi-year conraction in developing countries could potentially drive the price of oil back to the $20 - $40 range. Sounds just as crazy as $150 oil did 10 years ago when oil was $10/bbl.
tjgje at July 25, 2008 07:18 PM The thing that has been driving Chinese demand is that they subsidize the price of oil for domestic consumption. This is an expensive thing to do at these prices, but the last thing the Chinese government wants to do right now, after a very rough year (Tibet, Earthquake), is to irritate the people before the Olympics by raising prices. I would guess that they might start doing that in the fall.
Fat Man at July 25, 2008 07:53 PM If I recall correctly, world wide demand for crude basically increases in all but the most severe economic conditions, and even then, the year over year declines have been a) infrequent over the past 28 years and b) small. Ignoring the turmoil surrounding the OPEC embargo and the subsequent period in the early 80's for just a moment, *worldwide* demand only dipped once in 1993. Non-OECD consumers made up for declines in the OECD post 9/11. Since 1993 non-OECD oil demand has grown at a robust rate far exceeding OECD growth. While it seems possible a 2% reduction in crude use in the US and certain other OECD countries might bring world wide demand growth approaching flat, it does seem unlikely that growth will remain flat for too long unless an unusually dire economic future lays b...
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