January 13, 2005
The New Normal
Oil prices rise again, and $60 is the new $30...
Oil prices are climbing again, as supplies and other market conditions continue to drive the price up in a familiar pattern. Just the numbers are different.
This price plateau between $40-60 is here to stay. Here's why.
Oil supply is currently inelastic in terms of increasing capacity. When supply is inelastic, the price must rise until demand falls. Currently, the United States consumes a very large share of world oil production. However, developing nations such as India and China are seeking to greatly increase oil and energy consumption to further develop their economies. Since supply is inelastic, and there is no more supply to meet this increased demand, any increase in Chinese and Indian consumption must come from someone else, such as the United States.
Except that US demand is inelastic - there is very little downward mobility in US energy consumption levels.
The result is what we have now - OPEC producers cranking at full capacity, and unable to produce enough product to satisfy demand. As such, the price rises, and in a market where demand is inflexible, but so is supply, the commodity will go to the highest bidder - the United States.
Oil prices have risen, and will stay high, because the United States economy is absorbing the costs of a static supply of oil at a higher price point. At the higher price, the US can meet it's oil consumption needs, while pricing the speculative demand expansion of energy consumption in developing countries out - those countries cannot expand energy consumption at $50 or $60 a barrel.
This situation will not abate until there is an increase in elasticity in either the expansion of supply or retraction of demand - both very unlikely. Until then, the increased prices will rise and stay high - even climb - until it has risen enough to price developing nations out of the consumption increase equation.
The US economy can do this. Developing nations can not. As we see stories about $50 a barrel oil, recognize that this is the new norm. The days of $20 a barrel oil are past, at least until energy markets run on another commodity. The US economy so far has absorbed the price increase very well. While everything is more expensive, the fact that gasoline prices historically have been low and that oil prices only have a proportional effect on gas prices has meant some grumbling at the pump, but little more.
The wild card - the dollar. Oil transactions are in dollars. All of them. A radical change in dollar valuation can have interesting effects on oil prices. The cheaper the dollar (that is, the lower it's value against other currencies), the more likely supply remains strict.
Enough to make someone go out one day shootin' at some food, and up from the ground come a bubblin' crude...
Posted by MEC2 at January 13, 2005 11:01 PM