Over a barrel

Predictably, oil’s jump above the psychologically important $100 mark last week unleashed a fresh wave of gloomy prognostication.

Mainstream economists, already anxious over the global credit squeeze, fear pricy oil will make it even harder for America (and thus, Europe and even Asia) to recover from the subprime collapse. Those of a more apocalyptic mindset, meanwhile, go considerably further: $100 oil, they contend, offers still more proof that global oil output has “peaked,” and that the number of barrels that oil companies like BP and oil countries like Saudi Arabia can squeeze from the ground will begin a swift and devastating decline.

The truth is bit more complex.
Much of oil’s dizzying rise (it was $25 as recently as 2002) has been driven by what analysts call “above ground” risks – that is, factors that have little to do with how much oil is left in the ground. Oil speculators, for example, have goosed the price well above what is justified by supply and demand. Fadel Gheit, a veteran oil analyst in New York, points out that, historically, oil prices have run roughly triple what it costs to physically extract the crude from the ground. With extraction costs now averaging $15 to $18 a barrel globally, Gheit reckons we’re paying a “speculative premium” of as much as $57 a barrel. A weakening dollar is also to blame. Because oil is priced in greenbacks, the value of which has plummeted since 2001, surging crude prices at least partly reflect an ailing dollar. According to an analysis in the Wall Street Journal, if the dollar had instead remained as stable as gold since 2001, the price of oil would be just $39.

Lastly, demand for oil jumped far more swiftly than at any time in history – in large part because Asian economies are booming and Asian governments, desperate to keep the golden goose quacking, are subsidising oil consumption, thus muting pricing signals that would ordinarily curb demand. Such rapid increase in demand essentially caught the oil industry by surprise, and the big producers are now struggling to close the gap.

Yet not all of oil’s price rise can be explained by such above-ground factors. Oil output truly is flagging. Petro-states and oil companies are struggling to discover new oil fields as fast as they are depleting existing fields. To be sure, there is no consensus as to why discoveries are flagging: peak-oil proponents say it’s because there’s less and less oil to find; optimists, by contrast, say discoveries are being delayed by political barriers.

Yet on one point, both optimists and pessimists are in agreement: in the near-term, and probably the medium-term, the only thing that could possibly cure high oil prices is a recession, which kills demand for all commodities. And to judge from recent economic data, a recession is exactly what we may be getting – due to in part to those same high oil prices.

Guardian