I don’t mind eating crow when I’m wrong. I state my beliefs and I try to state my reasoning as well. When I am wrong, I’m wrong, and I admit it.
The core for me is, why has the price of oil risen so far so fast? My problem is, the sudden meteoric rise in prices, up 46% year to date, as it relates to your belief that the fundamentals of increased demand and reduced supply and expected supply are the basis for today’s oil prices.
No doubt a good chunk of that increased cost is due to the dollar’s tumble. And if the dollar strengthened to par with the Euro, we would see a direct proportionate decrease in oil prices.
That leave the balance of that 46% year to date increase, attributable either to fundamentals of supply and demand, or speculation, or both.
Here is the source of my doubts that supply and demand is responsible: the price of oil has been soaring since 2003. I can’t find a reasonable, logical explanation for the sudden shift in oil prices, straight up. Everyone has been aware of the stellar growth in developing nations. This is not something that just appeared beginning in 2003 and caught everyone off guard. Everyone has been aware of the possible plateau in world oil supply for quite a long time.
I simply can’t reconcile why oil was selling for $30 a barrel all through 2002, and suddenly spiked. I can’t accept that investors and retailers and supplies just woke up one morning in January 2003 and smacked their heads in shock with the sudden realization that oil demand was steadily increasing while oil supply was not.
What was this not priced into oil price in 2002? And in 2001? And in 2000, etc?
Now you know why I am having such incredible difficulty believing that market fundamentals alone account for $140/Bbl oil (in conjunction with a weakening dollar).
So, how is it that the market so suddenly and so rapidly discovered the looming supply/demand problem in 2003 and beyond, when they seemed to be completely asleep at the wheel prior to that time?
If you have a logical answer to that question — why the world market completely discounted the obvious and looming problem with future oil supply and demand prior to 2003, and just suddenly and forcefully discovered it — then I can start to open my mind to the possible idea that there is not a bubble in oil prices and that $140/Bbl oil is here to stay.
Any help you can give me in that regard is appreciated. Without a logical answer to that enigma, I just can’t accept the fact that prices went from $30 in 2003 to $140 in 2008 on the sudden revelation that world demand was increasing faster than world supply.
FWIW, I am assuming that if the dollar were to strengthen to par with the Euro, a Bbl of oil would cost $80 US today. So the rise in oil prices not considering currency is an increase of 170% in 5 years. I am finding it very difficult to believe that a 35% annual increase in the cost of oil since 2003 is due to market fundamentals of supply and demand alone, discounting the weakening dollar. Hopefully, you can explain to me why how this could be, because I really can’t see it.
Demand for oil in China, India, and other Asian countries grew a lot more than exected. For example, no one realized how huge the expansion in low-tech manufacturing in China was going to be. That boom enabled millions who previously could not own cars to now own them. Car ownership in developing countries has been growing far faster than anyone expected. And that, of course, has caused the demand curve for oil to shift out. Elasticity of supply is low, so small shifts in the demand curve mean large changes in prices.
In addition to that, the rate at which new oil fields were discovered declined, and some of the biggest oil fields in the world are starting to decline faster than expected. There were also some major disruptions in oil supply from places like Nigeria. The long-run elasticity of oil demand is quite low (~0.4). That means small changes in supply have a large impact on the price.
The bottom line is that the oil market is clearing: the price is such that demand ~= supply. If oil were overpriced there would be an oversupply of oil, and hence an inventory buildup. But that's not happening. Inventories are declining, which if anything, means the price is too low and demand is slightly above supply.