Crude oil prices have risen 46% in 2008 and 800% since November 2001, setting 28 record highs between January 1 and June 13 this year. On that date, it reached $139.12 per barrel and Saudi Arabian Oil Minister Ali al-Naimi said such prices were “unjustified by fundamentals.” An examination shows he’s only partially right:
Increased global demand. Ever larger chunks of the globe are being industrialized and require energy to power their production and transportation. This is highly correlated with per capita income, with wealthier countries consuming more barrels of oil per person than poorer ones, no matter the size of their total population. The Virgin Islands, for example, in 2007 consumed 1.0648 barrels of oil per person per day, Gibraltar 0.8571 and Singapore 0.1736. The U.S. consumed 0.0682; however, with a population of over 303 million people, that equals 20.8 million bbl/day, almost one-quarter of global usage. (Calculated from CIA World Factbook data.)
Decreased or threatened supply. It’s one of the ironic twists of history that most of the reserves of easily recoverable oil are located in the most politically troubled parts of the planet. Even a rumor of supply disruptions sends prices higher as refiners bid aggressively for the raw material to keep their plants productive. At the same time, these reserves are being diminished at an alarming rate and many oil-producing nations are reportedly past their peak levels, meaning production is unable to meet rising global demand. The remaining reserves are either not easily recoverable or require substantial processing, increasing prices further.
The weak USD. Oil is highly correlated with the strength of the U.S. dollar; 90–95% of the time, when the dollar falls, the price of oil rises. With USD currently at historically low levels, crude oil is skyrocketing. According to a report prepared by the Dallas branch of the Federal Reserve, the weak USD adds approximately one-third to the cost of a barrel of crude oil.
Speculation. When investments such as real estate and the stock market lose their shine, investors around the world purchase “solid” commodities such as gold and crude oil as a hedge against losses.
Potential solutions include:
Strengthen USD and curb speculation. As the U.S. economy recovers, currently expected toward the end of 2008 and early 2009, the dollar will rise to follow, easing the financial pressure on commodity prices and making them less attractive to speculators. This most obvious solution has been touted by financial and political leaders around the globe, including Russian Finance Minister Alexei Kudrin and OPEC President Chakib Khelil, while in late May, French Finance Minister Christine Lagarde offered to “arm twist” whoever is holding the dollar down and the euro up.
Decrease global reliance on oil, foreign or domestic. Although strengthening USD will partially ease price pressures, only bringing supply and demand into balance will effect any permanent change. On the demand side, this means increasing reliance on alternative energy sources such as geothermal, hydro and wind power. Increasing MPG ratings for vehicles and encouraging more efficient driving habits certainly won’t hurt.
Find ways to tap currently unusable reserves. On the supply side, higher prices make it cost-effective to drill in areas previously considered marginal and to find production methods for unconventional crude sources such as oil sands and oil shale. Also, cleaner drilling methods and more stringent environmental regulations may encourage exploration in sensitive areas such as Alaska.
End subsidies. Many developing countries have long subsidized the price of gasoline to encourage growth, sending demand higher in these regions. However, the financial strain for these governments is becoming unbearable. China recently raised their gasoline prices by 18%, and Indonesia, Taiwan and Pakistan all reduced their subsidies as well. As much of the rising demand for crude oil is centered in these regions (in developed economies such as the U.S. it’s currently decreasing) ending such subsidies could, if not lower demand, at least slow its growth.
Because there is no single cause for high crude oil prices, there is no simple solution. One outcome of the June G-8 meeting in Japan was a united call for the International Energy Agency and the International Monetary Fund to examine the problem in greater detail, and the U.S. Commodity Futures Trading Commission has announced an investigation into possible means of curbing speculation. With higher energy prices sending inflation progressively higher around the world, hopefully one of these solutions will ease the pressure before Mad Max comes to call.
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