Supply side to blame for high oil prices

Oil prices careened toward $117 this week, providing further, painful evidence of the virtual “perfect storm” of things gone wrong in global oil markets. Unfortunately, the long list of problems driving high oil prices shows few signs of letting up anytime soon.

A number of factors are at work in this latest run-up in prices, including increased demand, geopolitical problems in the key producing countries, speculative activity in futures markets, and investors’ frantic efforts to hedge against dollar-based assets like oil.

These are important elements in today’s painful price equation. But the real epicenter of this crisis is a slow-motion global oil supply shock that is now gathering pace.

Despite what many pundits say, oil demand is not really the central problem. True, there has been a huge shift in the sources of demand, away from the rich industrial countries and toward China, India, the Middle East and Russia. But the pace of aggregate demand growth in recent years has not changed significantly and, in fact, has slowed. In short, there has been no demand shock.

Rather, the real culprit is on the supply side. Unlike the sudden supply shocks of the 1970s, this crisis is the culmination of the gradual erosion in global capacity growth, which leaves oil demand chronically bumping up against stagnating production capacity.

SF Chronicle