No Nonsense
Politics and price of oil
WORLD oil prices have risen by nearly 50% since the beginning of 2008, and nearly doubled over the past year. Both economic and political factors have driven this unsettling rush in oil prices. However, some recently proposed remedial measures here in the US appear nonsensical. President George Bush and presumptive Republican presidential nominee John McCain both have recently proposed withdrawal of the 1990 federal moratorium on offshore oil drilling.
Last month, the Senate defeated a Democratic sponsored bill designed to impose windfall-profits tax on oil companies, and empower the US attorney general to sue Opec on antitrust grounds (price collusive behaviour).
Arguably, a windfall tax would invariably hold back investment in new energy sources; suing Opec (for cartel behaviour that restricts output and fixes prices) will trigger a trade war -- a no-win vitriolic game of tit-for-tat.
Against the backdrop of these nonsensical non-solutions, the US Energy Information Administration (EIA) revealed that even if oil drilling tapped an estimated 18 billion barrels under coastal waters that are currently off-limits, oil prices wouldn't see any drop until 2030.
The moratorium was imposed to benefit tourism, fisheries, small businesses, and coastal dwellers. Damage to these resources is too high a price tag for an expected negligible price decline that is 10 to 12 years down the line, by which time many alternatives to oil may become reality.
Economists dismiss all this presidential campaign rhetoric about lifting drilling moratorium, windfall tax and 18.4 cents federal gas tax relief (summer tax holiday) as mere distractions from the real issues. Why so?
First, new production would take about 10 years to affect the supply, if at all. Secondly, since oil production from West Texas and the North Sea continues to decline, the 18 billion or so barrels of new oil under coastal waters wouldn't be large enough to add a net positive to worldwide oil supply. Third, off-shore drilling does nothing to slow world energy demand, which is the real perpetrator in runaway oil prices.
EIA estimates show that worldwide oil demand outstripped supply in 2007 by nearly 850,000 barrels a day -- approximately 3.6 million gallons of oil per day imbalance between consumption and production. Thus, the unrelenting oil price increase is simply the out-play of demand exceeding supply, implying that the market is functioning by laissez faire rule.
Worldwide oil production has been at its plateau since 2005, at nearly 85 million barrels per day. Then, supply exceeded demand by nearly a million barrels a day, which kept the price cheap.
According to EIA, oil demand in the US over the last four years has increased to around 3.3%, as opposed to a jump of 8.6% demand in the rest of the world driven by over two billion new consumers in India and China tiptoeing into a western lifestyle.
Starting 2006, increased demand gradually matched supply and gasoline prices at the pump hit the $3/gallon mark in the US. But in early 2007, demand exceeded supply and prices started surging up. The higher price should have increased supply to keep pace with demand as law of supply predicts. Oil market analysts advance three conceivable scenarios why that didn't happen:
- In the late 90's, prices declined to around $10 a barrel, causing disincentive in investment in exploration and production capacity;
- Geopolitics is also a factor. State-owned oil companies in countries like Iran, Venezuela, and Mexico have diverted profits from reinvestment in modern refineries and additional production capacities to finance their governmental operations;
- The most discouraging possibility is that the world may have reached the "Hubbert peak" (first described by King Hubbert in the 1950s) in which the world has used half of all oil reserves and that production will soon decline.
- Continuing depreciation of the US dollar (crude oil is priced in dollars);
- Risk premium associated with oil due to political instability in oil exporting countries (Iraq, Iran, Nigeria and Venezuela) is driving spot prices and long-term, forward contract prices by as much as $20 per barrel;
- Speculation by energy traders is believed to add as much as $10 per barrel;
- Saber rattling and heightened tension involving Iran's nuclear program adding another $10 to $15 per barrel -- at least
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