Mr. Oil Market Gets Out the Megaphone

Martin Wolf on how the high price of oil is Mr. Market's way of giving us tough love:

FT.com / Columnists / Martin Wolf - The market sets high oil prices to tell us what to do: [O]il... is a finite resource; it drives the global transport system; and if emerging economies consumed oil as Europeans do, world consumption would jump by 150 per cent. What is happening today is an early warning of this stark reality. It is tempting to blame the prices on speculators and big bad oil companies. The reality is different.

Demand for oil grows steadily, as the vehicle fleets of the world expand. Today, the US has 250m vehicles and China just 37m. It takes no imagination to see where the Chinese fleet is headed. Other emerging countries will follow China’s example.... It looks increasingly hard to expand supply by the annual amount of about 1.4m barrels a day needed to meet demand. This means an extra Saudi Arabia every seven years.... [I]f speculation were raising prices above the warranted level, one would expect to see inventories piling up rapidly, as supply exceeds the rate at which oil is burned. Yet there is no evidence of such a spike....

[I]t seems... likely that such speculation as there is has been stabilising, rather than destabilising: in other words, it is moving prices in the right direction, in order to reduce demand. Will the high prices succeed in doing this? Certainly. Demand has to match supply for a simple reason: we cannot burn oil that does not exist.

The price spikes of the 1970s were followed by big absolute falls in demand and output.... Both forces should work again this time, but to a much smaller extent.... On balance, it is quite unlikely that aggregate demand for oil will collapse, as it did after the two previous price spikes.... So what should be the response to these simple realities? Here are some obvious “do nots” and “dos”.

First, do not blame conspiracies by speculators, oil companies or even Opec. These are the messengers. The message is one of fundamental shifts in demand and supply. If speculators push prices up in response, they are helping the adjustment. Even if Opec keeps output back, it is preserving a valuable resource for the future.

Second, do not blame the emerging countries for their growing demand. Citizens of rich countries must adjust to the higher prices of resources that the rise of the emerging countries entails. The only alternative is to attempt to destroy those hopes. That would be a blunder and a crime.

Third, understand that prices at these levels are now playing a big macroeconomic role. At $100 a barrel the annual value of world oil output would be close to $3,000bn. That is 5 per cent of world gross product. The only previous years in which it was higher than that were 1979 to 1982.

Fourth, adjust to high prices, which will play a big part in encouraging more efficient use of this finite resource and ameliorating climate change. The current shock offers a golden opportunity to set a floor on prices, by imposing taxes on oil, fossil fuels or carbon emissions.

Fifth, do try to reach global agreement on a pact on trade in oil based on the fundamental principle that producers will be allowed to sell their oil to the highest bidder. In other words, the global oil market needs to remain integrated. Nobody should use military muscle to secure a privileged position within it.

Finally, do become serious about investing in basic research into alternative technologies. Energy self-sufficiency is an implausible goal. Investing for a post-oil future is not....

The great event of our era is the spread of industrialisation to billions of people. The high prices of resources are the market’s response to this transforming event. The market is saying that we must use more wisely resources that have now become more valuable. The market is right.

Comments

[Frank the sales forecaster]

It seems to me, that by allowing them to peg their currency to ours, we get to share more of the increase in energy cost created by their demand increases. With free floating exchange rates the "local cost" of energy would be greatest for those economies using energy at the greatest rate of increase (faster growing economies have stronger currencies/slower growing economies have weaker currencies) and the lower costs would be afforded to economies with demand decreases. By allowing yuan pegging we are subsidising their energy consumption.

[PeeDee]

Oil wants to know how valuable it really is. "Tell me you love me."

One thing Martin fails to mention:

Don't blame the countries that happen to have oil left for selling it at whatever price the market will bear; and thus accumulating much of the surplus wealth (and power) for generations to come.

[bigTom]

Another thing he seems to neglect, is the very real possibility that future supplies may be decreasing in the not too distant future. Whether it be because of complacency, design, or just plain geology(running out of decent places to drill), The world has just run an experiment with high oil prices. The key swing producers have been observing the results of the this experiment in high prices. As little as a year ago, the prevailing wisdom was that if prices were allowed to go above say $75 serious, and likely permanent demand destruction would occur. Now that the experiment has been run, the psychology within OPEC has changed. They no longer see $100-$150 oil as being dangerous to their future. Secondarily IMO OPEC members have become aware of the finite nature of their oil fields, and their calculus concerning how aggressively they should invest in production capacity has changed. For these reasons the probability that production five to ten years from now could be considerably less than current should not be discounted.

[phil]

While I agree with Brad's and Martin Wolf's sentiments, it is still possible that inventories are indeed being built up - in the US Strategic Reserve. There's a lot of war talk coming out of Jerusalem.

http://tpmcafe.talkingpointsmemo.com/2008/05/14/iran_whats_the_game/