I’m not looking for conspiracy theories about the world ending, but I am curious as to whether it’s simply a matter of higher demand, or Opec playing the markets or even whether this is a side-effect of the U.S. in Iraq - what is Iraqi production like at the moment? If they’re not at normal capacity, will it bring prices down a bit once (if?) they do get back on track there?
It’s a combination of all of them. One important factor is China, which is rapidly increasing oil demands (high demand). Of course, the U.S. hunger for energy isn’t decreasing either - wars are expensive in more than one ways, and yes, Iraq isn’t producing at full capacity. Also, Another factor is limited refinery capability. I think also that several parties in the oil trade are beginning to understand that since they’re reaching and passing peaks in several quantity areas (refining, pumping the stuff up, discovering new reserves), they are increasingly starting to see the end of the fuel reserves, and realise from here on making the most of their reserves means that their only growth potential lies in maximising profit.
Adn yes, Iraq is definitely a factor that could bring prices back down a little temporarily:
http://www.globalpolicy.org/security/oil/irqindx.htm
How has has all this changed with time? How come these conditions weren’t in place just two short years ago (heck … make that 19 months ago)?
On January 1st, 2004, I bought gasoline for $1.25 a gallon at a local convenience store. In late April 2004, it was around $1.65 - $1.70. January 1st of this year, a rural station just off the interstate in Mississippi was selling it for $1.49 (prompting nearby towns to sell gas at $1.50 - $1.59 for about a week). Today, it’s around $2.01 - $2.15 in the area.
Now, was Chinese demand really and truly significantly lower 19 months ago? The refinery capacity issues weren’t on the radar 19 months ago? The Iraq war was 8 months old when gas was last $1.25/gal – so we can consider that a static variable, right?
I don’t know a lot about this issue, and I’d love for my ignorance to be slain. But right now, my understanding is that oil prices are more or less set by fiat, and are not especially driven by external factors in the global marketplace*. Things like the war in Iraq and miniscule jumps in Chinese energy consumption are more excuses for raising oil prices, not the drivers behind oil prices.
So what’s the Dope?
** - I understand that the marketplace is functioning in the sense that the OPEC nations are charging what they can get – people are still paying for the oil. But why weren’t they charging these prices 19 months ago? Surely they weren’t cutting into thei profits purposely? And if they were … why? And why the sudden ramp-up in prices instead of a gradual rise over, say, five years?*
Let’s start with a quote from Micawber in David Copperfield:
This is known as the threshold effect. At the margins pricing policy totally changes.
So even a small increase in China’s need can set off effects throughout the oil industry. If there is even slightly more demand than current supply the bidding for the supply tends to rise sharply for fear of being shut out entirely.
And China’s needs have been increasing incredibly fast. Their GDP has grown more than any other country’s and their oil imports “doubled over the past five years and surged nearly 40% in the first half of 2004 alone.” according to Time magazine.
You don’t need to postulate a conspiracy when the demand is rising this quickly.
Speaking of China, i heard that China is trying to buy Unocal.
Limited refinery capacility could definately affect the price of gasoline, it would not adversely affect the price of crude. In fact, for a fixed level of crude production,
limited refinery capacity will reduce the price of crude, as the demand from refineries will decline.
Thanks for the article, Exapno.
That same article you linked attempts to offer up some weak counterpoints that nevertheless should be addressed (wish the article did a better job of this):
OK, so what is Jeffery Logan talking about? If he’s says China’s energy needs aren’t to blame for rising oil prices since January 2004, then what is (I understand it’s not an easy, one-cause thing)?
Also, that 81-million barrel figure quoted above – that’s what I meant about oil prices being set by fiat. Better I should have said oil production is set by fiat, as I understand it. Recognizing that oil is a finite resource, my understanding is that OPEC could snap their fingers and summarily get oil production up to, say, 100 million barels/day. That, in turn, should lower oil prices per barrel.
But – what’s their motivation for producing so much and devaluing their resource on the open market? Right … there is no such motivation, you would think. But supposedly OPEC was overproducing in 2002 and 2003. Why were they overproducing then? What was going on … what were their motivations?
I don’t know the responses to this question, but two related comments :
-I understand (though I might be mistaken) that the current production is close to the actual maximal production capacity.
-The OPEC countries don’t necessarily all agree. Country A doesn’t necessarily accept to reduce its production because other OPEC countries think it should. So they might have been overproducing due to a “lack of discipline”.
I don’t have the OPEC only production figures, but here is the average daily
world production by calendar quarter for the International Energy Agency:
2001 77.6, 76.1, 76.9, 76.6
2002 75.9, 75.6, 76.1, 77.8
2003 78.4, 78, 79, 81.4
2004 82.3, 82.3, 83.4, 83.9
2005 83.9, 84.2
The last quarter was projected by the IEA. World production has never been as great. About half the quarters, production slightly exceeded consumption and about half the reverse.
You are going to have to search really hard to find anyone in the oil industry who believes production in the short term could reach 100, and there’s a growing minority who believe 100 can never be reached thru conventional production.
The “100 million barrels/day” figure isn’t important. I threw that number out there just to make the point that I understood that world oil production (mostly OPEC, and especially Saudi) was currently siginificantly below capacity. My understanding could well be wrong, but I recall radio news reports from spring 2004 that Saudi Arabia was suddenly cutting production way back in order to bring prices to a more profitable level for them (nothing wrong with that, as far as it goes).
Sorry, can’t cite that – just going from memory.
But another question is begged: there are numerous oil fields the word over that have been undrilled because of economics – it costs too much to get oil out of some places. Exapno’s article mentions one large field in western China. ANWAR in Alaska is another one, and there are many untapped fields in Siberia.
So, if we can assume world production really is close to being tapped out, just when will the economics be right to drill these as-yet untapped fields? Seems there is money to be made … so just how high does oil have to get per barrel before some of these unused fields are tapped?
I agree that current oil production appears to be near capacity, from what I’ve read. And increasing crude oil production would have little effect on the market because there is no excess refinery capability to process it. Every time a Saudi minister comes to the U.S. he chides us for not building a new refinery in 30 years.
And the economics of production are interesting. Current demand hovers very near current production. This drives the price up - at least on the spot market, which is what those $60 a barrel prices refer to. The spot market is a very different animal from the long-term contracts that most oil companies have. You have to think of the spot market price like the marginal tax rate: it’s what you pay for the last bits, not for the entire supply. Increasing production may change the spot market, but it has little real effect on the overall costs of gasoline.
bordelond, there’s no easy way to predict the future. If OPEC overproduced it 2002 and 2003 - and I don’t know that they did - they may have forecast the growth in oil demand incorrectly or too early, or they may just have decided to create a reserve in case of a forthcoming growth in demand.
You say you know that it’s not a one-cause thing, but you seem to want an one-paragraph explanation for one of the most complex political-industrial-economic subjects in the world.
OK, here it is. OPEC is making more money because it can. 
Probably at least $100 per barrel. Maybe twice that.
But that price would spur alternate energy production and use, as well as conservation. So the demand for oil would be somewhat lessened. This would be a complex equilibrium problem and not solvable in advance because the tiniest change in assumptions would grossly change the answer.
Quite the contrary – I expect discussion on this topic to be lengthy and involved. I am trying to get past the pat, simplified answers (which is why I was dissapointed that the Time article you linked didn’t further expand on Logan’s comments).
Thanks for your input on this issue.
Goes without saying. It just seems that a lot of explanations of rising oil prices discount the profit motive.
…
Re: overproduction in 2002-2003 – Exapno, have you ever heard that American gasoline prices in those years were “artificially” low? I have heard that on numerous electronic media, and many here have posted it. I am assuming that “artificially low prices” more or less equals “overproduction”. Not a safe assumption?
[rhetorical question]
Damn, really? Wonder if anyone is out there building a better mousetrap that would make drilling new fields economically viable at $75-80/barrell?
[rhetorical question]
This oil crisis seems like a lot of deja vu from back in the 1970’s. I remember thinking 44 cents was high, but it just kept going until it got to $1.00 and stayed there for several years. I just hope we are smarter this time and do more about alternative sources of energy and conservation.
I recently saw a NOVA on China. The auto industry there is very important to keep their economy going. If their economy falters the regime may be overthrown. The important point here is that they will keep making autos and when they catch the U.S. in the automobiles per individual category there will be 800,000,000 autos in China.
[sup]Why no mention of India?[/sup]
I don’t have many cites, but I’d imagine that the USA is probably the country with the most autos per capita, or at least very, very close to the top. It’s such an important part of our culture that even our very, very poor have cars, and this contributes towards the per capita count. In most of the developed world, the very, very poor are defined quite differently than here, and they do not possess cars. So for China to really attain a similar ratio, they’d have to equal or surpass us in per capita earnings or wealth. That may not be impossible, but we can be reasonably sure that the government that exists there now won’t resemble the government that will be there if it happens.
The other thing is parking. New Chinese cities, like Shenzhen, are built to accomodate a very high ppulation density compared to the United Sattes. Single family homes are very rare in Shenzhen; residential neighborhoods are filled with block after block of boxy five and six story apartment buildings. Parking is usually limited to one space for every two to four apartments.
If you think nations like the US, Canada and Australia have problems with urban sprawl, picture a future nation of two billion people, with a living standard equivalent to that of the US in the 1970s or 1980s. Imagine the sprawl, imagine the traffic, imagine the energy consumption, imagine all the housing built not that long ago for a population that was once far less wealthy … it’s going to be a mess.
Ad before I gorget … automobile ownership is also skyrocketing in India and Eastern Europe. The suburbs of Eastern European cities aren’t that dissimilar to what’s found in North America; single family houses, major arterials lined with big box stores and enclosed malls, and growing expressway/freeway systems. Increasingly, a car is becoming essential for day-to-day life.
A recent NPR segment attempted to answer the question. One factor touched on is that present refineries are running at capacity, and no new refineries have been built in a number of years, owing to NIMBY.
The part not mentioned by the story is the record profits of big oil, which has chapped my butt for quite a while. Other commodities such as electricity, gas, and phones have been regulated by government bodies such as a PUC, yet motor fuels aren’t subject to those rate caps, a situation which never made sense.
Electricity, natural gas, and phone service were regulated because they were monopolies; i.e. for the convenience of customers only one of each service was given a franchise in any community. The government then stepped in to ensure that consumers had some protection against monopolistic practices, like price gouging.
Motor fuels were never given monopolies and so were allowed to compete in the marketplace. And now that competition has been allowed in electricity, natural gas, and phone service, those industries are no longer regulated either.