Jun 18, 2008


If I read another article about how speculators or hedge funds or the big oil companies or (insert conspiracy theory here)(UPDATE: I knew it. It's the friggin Democrats) are driving up the price of oil I'm going nuts. Nuts from a couple of different standpoints.

First of all, why do we have so much difficulty believing that supply & demand are driving these increases.

We can all agree demand must be going up at a decent clip. Whereas most families drove cars 20 years ago, most now drive SUVs and pickup trucks. The way these two classes of vehicles are made makes the latter very fuel inefficient. We have 2 enormously populated countries growing to a point where a significant part of the population can now buy cars and use cleaner burning fuels (China, India). We have a global economy where manufacturing and consumption are rarely collocated and therefore shipping is required to source our products (New Zealand lamb anyone?).

On the supply side we have, on a 5 year time scale, very little ability to increase oil production. We used to have that ability. That ability was known as Saudia Arabia. They've traditionally been able to increase the spigot flow. It doesn't seem like it can anymore. Oil will still come out but it's looking increasingly unlikely that they can increase production. What about other sources?

You probably heard about those huge oil fields just found off the coast of Brazil. Maybe the size of Saudi Arabia's Ghawar oil field. If we are lucky those will come on line in 10 years. Want to drill in Alaska or off the coast of California? We're talking minuscule amounts of barrels per day compared to what is needed. Couple that with declining oil production capabilities in much of the West & Russia, and political strife in Africa (which can produce nice clean crude when it's not at war with itself), and it's really hard to supply more oil.

No, speculators are not to blame. Hedge funds are not to blame. Big oil companies are not to blame. We are to blame.

My second problem is the use of this term "speculator". What is a speculator? It is basically an investor. Anyone who buys something but doesn't use it outright is a speculator. If you have a 401k you are a speculator. But it's always used in a pejorative sense. These so called speculators are making a bet on oil (and many other commodities) to make money and that's bad for some reason. Speculators actually make both bets it will go up and bets it will go down. This is actually very good because it introduces liquidity into the commodity market. Less liquidity means more price spikes. Without speculators in the oil markets we could have even higher price spikes.

But so what? What if they made the price of oil go up? Why should this not be allowed? Did anyone scream 'speculator' when we had an Internet bubble? Did anyone scream 'speculator' when we had a real estate bubble? Very few if any. Why is oil different?

This will end the same way the oil crisis in the 70s ended. The major players in oil production will end up spending a lot of time and money finding new oil and people of the world will adjust by using less oil. We've already seen the biggest drop in miles driven in the US ever. Supply and demand will come back into equilibrium and we'll have lower oil prices. It might take a while but it will happen.

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