Behind high oil prices

Due to the destruction of refining capabilities by hurricanes, and an expectedly large decline in commercial oil reserves in recent days, the New York market, for the first time, closed on a price above 80 US dollars per barrel on September 13; and hit a new record in the history of nominal prices. As a matter of fact, oil prices have been rising since 2002 at a pace and with a lasting time rarely seen in “peace” time. So, what exactly is behind this round of price hikes?
Firstly, an increasingly short supply of oil in the world is the fundamental cause. According to statistics from the British firm BP, the world has been demanding more oil than can be produced since 1981; and the case is still the same today. Currently, oil production in most countries has already or will soon go down – leaving less of a surplus to use – but at the same time, demand keeps increasing. The supply remains tight and prices keep soaring despite OPEC’s decision to increase crude oil production by 500,000 barrels per day as of November 1. With little price elasticity from both demand and supply, any trivial event will send prices skyrocketing.

Secondly, short-term speculations on oil futures by large amounts of funding also drive prices up. A Citi report in May 2006 mentioned that US commodity markets hold an average speculation volume of over 120 billion US dollars each month, chiefly coming from natural gas (30.3 billion dollars) and crude oil (30.1 billion dollars). The numerous speculation deals have a massive impact on oil futures prices considering the leverage effect of futures margin deals. With excessive liquidity worldwide, funds behind oil futures speculations will remain the same.

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