Re: [OPE] Reflections on the oil price controversy

From: Anders Ekeland (
Date: Wed Jul 16 2008 - 02:34:26 EDT

Hi Jurrian,

I am not quite convinced that speculation is the main reason.

1) If demand is rather inelastic (vertical) then 
no matter how marginal the excess demand is you 
will get a steep and rapid price increase until 
there is no more willingness to pay. It becomes 
and auction and governments are very eager to have oil - almost at any price.

2) Since consumers to a large extent has been 
shielded from the price rise - in Norway the 
price at the pump has gone from 2 USD to 2,6 (per 
liter) - but that is still cheaper in real terms 
than early eighties, so consumption has  not go down very much.

3) How long governments are willing (able) to 
subsidy is an open question, but before consumers 
are confronted with real prices - demand will 
tend to exceed supply and price will stay high. 
It may fall dramatically as soon as there is a bit of oversupply, but:

4) In my opinion oil has not been priced 
competitively for a long time. There has been an 
consumer surplus of immense dimensions. People 
are willing to pay a lot more than they have done 
up to now for petrol. US consumers has for 
decades had ridiculous low petrol price seen with 
Norwegian eyes - and since the are as rich a us - 
they can "easily" pay the double.

5) I am pretty sure that prices will not fall 
back to old levels (20-30-40-50) USD. Because too 
many actors in "system" has learned that there is 
a willingness to pay, so it is tempting just to 
keep production at todays level and the ever 
increasing inelastic demand will keep prices high (> 100 USD)

6) The OPEC might also fear that renewable energy 
"backstop technologies" might come in order to 
reduce CO2 emissions and reduce the price you can 
get for oil on a long term basis - whatever the 
current price.  Then it is rational to take out 
as much as possible of the consumer surplus now - 
their last chance! If this is correct they will 
keep a high oil price for a couple of decades. 
This will of course spur the introduction of 
wind-mills, bio-fuel, better housing/heating etc. 
etc. But that is underway  - way too slow for the 
stopping global warming, but maybe enough to 
change the strategy of Saudi-Arabia and OPEC.

7) Oil producers outside the Middle-East need the 
extra money - L.ex. Venezuela - so why shouldn't 
they cut back production just a little bit to 
keep prices > 100 USD? The US is not so popular 
in the M-E that they cannot consider letting US 
consumers and elites bleed and feel some pain - 
in a situation where they cannot directly be blamed for it etc. etc.

8) My point is that it is no problem of imagining 
a demand curve that would give a steep rise in a 
very short period. If that is so remains to bee seen.

9) If the main culprit is speculation, we should 
get a fall and then a markedly slower rise, but I 
think we will see high (>100 USD) as the norm in 
the medium term, i.e. until 2015, due to increased and inflexible demand.

10) But I would not bet very much on this since 
we have all learned that the actors in this game 
*make* the oil price unpredictable. The result of 
conflicting and mixed strategies gives an 
unpredictable path. But my expectation is >100 USD.


At 20:30 15.07.2008, you wrote:

>A while ago Paul Krugman argued:
>Faced with higher [oil] prices, drivers would 
>cut back on their driving; homeowners would turn 
>down their thermostats; owners of marginal oil 
>wells would put them back into production. As a 
>result, the initial balance between supply and 
>demand would be broken, replaced with a 
>situation in which supply exceeded demand. This 
>excess supply would, in turn, drive prices back 
>down again — unless someone were willing to buy 
>up the excess and take it off the market. The 
>only way speculation can have a persistent 
>effect on oil prices, then, is if it leads to 
>physical hoarding — an increase in private 
>inventories of black gunk. This actually 
>happened in the late 1970s, when the effects of 
>disrupted Iranian supply were amplified by 
>widespread panic stockpiling. But it hasn’t 
>happened this time: all through the period of 
>the alleged bubble, inventories have remained at 
>more or less normal levels. This tells us that 
>the rise in oil prices isn’t the result of 
>runaway speculation; it’s the result of 
>fundamental factors, mainly the growing 
>difficulty of finding oil and the rapid growth 
>of emerging economies like China. The rise in 
>oil prices these past few years had to happen to 
>keep demand growth from exceeding supply growth. 
>This argument just isn't very credible, given 
>the relative "inelasticity" of world oil supply 
>and demand, and it conflates shortterm and 
>longterm trends. Chaudhuri replies to this line 
>of argument in a punchy article:
>"The biggest argument for speculation to be the 
>single-most important cause for oil price 
>increases in 2008 is: What else could have 
>doubled the price of oil in one year?" 
>Chaudhuri elaborates:
>"Consider first the oft-mentioned demand from 
>"China and India" which is frequently put 
>forward as the principal reason why oil prices 
>are going up. (...) How can.. [the] small 
>increase in demand increase oil prices by 100 
>per cent between July 2007 and July 2008? The 
>supply of crude oil has been remarkably stagnant 
>over the last three years. (...) It is the very 
>short-term supply disruptions which seem to be 
>more important for an increase in oil prices. 
>Real disruptions may come from labour strikes in 
>Venezuela [and Brazil], hurricanes in the Gulf 
>of Mexico, and rebel attacks in Nigeria. Given 
>that the demand and supply situation is so 
>tight, even the slightest of bad news can 
>increase the price of oil in the futures and 
>spot markets noticeably. Asserting that the 
>"weak dollar" is a significant reason behind the 
>rise in oil prices has become as ritualistic as 
>asserting that "China and India" are the cause. 
>(...) However, for the first six months of 2008 
>the dollar has depreciated against the euro by 
>only 7.5 per cent, while oil prices have gone up 
>by about 50 per cent. Surely, both Americans and 
>Europeans are paying much higher prices for oil 
>than can be explained by a "weak dollar". The 
>energy ministers of Saudi Arabia and Qatar 
>asserted for the first time in public at the 
>recent Jeddah meeting of major oil producing and 
>consuming nations, that speculation in the oil 
>futures markets was the most important reason 
>why current oil prices are going up. (...) In a 
>recent testimony to the Senate, a hedge fund 
>trader presented data to show that outstanding 
>speculative positions in all commodities futures 
>has reached $250 billion by March 2008, as 
>compared to only $13 billion at the end of 2003. 
>(...) If speculation is what is driving oil 
>prices up, then it stands to reason that such 
>high prices should lead to an excess supply of 
>crude in the world. There are signs that such an 
>excess supply is indeed building up, albeit 
>slowly, much like the way the excess supply of 
>housing emerged in the United States. Fuel 
>consumption has declined in the US sharply. We 
>have already noted that oil consumption in Japan 
>and Germany are actually decreasing. Consumers 
>in China and India have been insulated from the 
>high world prices of oil until very recently 
>with domestic subsidies. However, China has 
>raised the prices of various petroleum products 
>amounting to an average increase of 18 per cent, 
>and so has India, by 13 per cent. The decrease 
>in the demand for oil will start strengthening 
>This is also more or less what the G8 luminaries 
>are banking on - that, within the space of one 
>year, or one and a half years, a more favourable 
>supply-demand relationship for traded oil will 
>be reached, causing the oil price to drop. Also, 
>some financial steps at least could be taken to 
>reverse the falling dollar exchange rate. But 
>that is where Krugman's argument comes into 
>play: the longer-term oil position is in fact 
>that supply lags demand, plus, assuming the oil 
>price has again dropped strongly in the future, 
>then the large speculators start buying again 
>(of course you can also make money from 
>"shorting" on falling oil prices; all the 
>speculator needs is a bit of price volatility). 
>This would not happen only in the case that more 
>profit could be obtained from some other source, at relatively low risk.
>There can be no doubt that high oil prices wreak 
>havoc on the economies of poor countries, and 
>thus that they contribute directly to the food 
>crisis. But leaving aside hungry people in some 
>faraway country out of their field of vision as 
>they ogle the balance sheets, there is nowadays 
>increasing moral uncertainty about the justification of speculation as such.
>The orthodox view is that the role of the 
>speculator in a market economy is mainly (1) to 
>absorb risk, and thus insure the value of 
>capital investments, by using his own capital 
>with the chance of monetary reward, (2) to add 
>liquidity to the marketplace, compensating for 
>volatility and facilitating market expansion, by 
>making capital funds available that would 
>otherwise be underutilised, or not utilised at 
>all, (3) to allocate capital so that it is most 
>efficiently used. But this whole reasoning 
>doesn't hold much water in aggregate nowadays, 
>when we look at what empirically happens in the world.
>“It is indisputable that the global glut of 
>liquidity [what Jan Toporowski calls "capital 
>market inflation"] played a role in the 'reach 
>for yield' phenomenon and that this reach for 
>yield led to strong demand for and supply of 
>complex structured products,” says Gerald 
>Corrigan, a partner at Goldman Sachs and an 
>éminence grise of the financial world." 
>The paradox is that the more capital funds are 
>available which are insured against risk, the 
>more bets are staked on future income and future 
>wealth, so that the risks in fact proliferate. 
>The gambit is to claim tomorrow's wealth today, 
>utilising the credit system, but this leads to 
>the overextension of credit in various forms, 
>without however anybody being able to specify 
>any limits to the game, other than observed 
>empirical cases of business collapse, and 
>without being able to predict adequately what 
>the repercussions of such collapse will be.
>In turn, that gives rise to the ideological 
>problem, that curtailing speculation (through 
>more regulation) would contradict the doctrine of free trade.
>The benefits of free trade are always supposed 
>to outweigh the costs, if not in the short term, 
>then in the long term. But even if free trade 
>obtains more benefits than costs, the benefits 
>and costs are empirically very unequally 
>distributed between nations and social classes. 
>That may not appear to be such a problem, if 
>everybody is making gains in trade anyway, be it 
>in unequal amounts (for example, poor people 
>earn $2 per day instead of $1 per day), but it 
>does become a problem if free trade becomes a 
>zero-sum game, in which the benefits of some are 
>directly and transparently at the cost of others.
>Because in that case, it becomes very difficult 
>to convince a large number of people of the 
>benefits of free trade - given that they are 
>losing more money than they gain. And that 
>creates conflicts among different fractions and 
>strata of the propertied classes about the 
>justification of claims to wealth, the corollary 
>of which is recurrent crises of political 
>leadership, and an increasing turnover of 
>politicians - generating political instability, 
>which contributes to further market uncertainty.
>It is not just that the more the complex web of 
>financial claims and counterclaims expands, the 
>more difficult it becomes to unite people over 
>an economic programme that would benefit all - 
>but that it becomes more difficult to evaluate 
>what the costs, benefits or outcomes of any 
>given economic programme will be, as such, 
>anyhow. There are just so many different 
>potential "stakeholders". And that leaves 
>economic science with a bunch of metaphors and 
>dogmas suggesting "what would be good for people".
>In the end, of course, people will act according 
>to their own perceived interests, regardless of 
>doctrine, but insofar as they do this, it 
>confounds the conventional "rational actor" 
>models of conventional economics. It is 
>therefore hardly accidental that psychologistic 
>"behavioural economics" becomes the vogue - all 
>the economists can really do in this predicament 
>is to describe the costs and benefits of 
>economic action for individuals in their 
>specific situation. But all that means, is that 
>economics has little to say anymore about 
>society as a whole, i.e. the ensemble of human 
>relations in which individuals are located, 
>socialised and acculturated. It becomes purely a 
>defence of the goodness of private property relations, no more, no less.
>The confusing thing there is that more and more 
>money is made, by people who use money that they 
>do not actually privately own. Money seems to 
>grow on trees, though actually it doesn't. All 
>told, wealth-creation gets an added mystique 
>thereby. It all seems to turn now on how you 
>behave, and all economic problems can be then be 
>reduced to the behavioural problems of 
>individuals. To solve economic problems... all 
>you need to do is change people's behaviour. But 
>what if they don't want to change? In that case, 
>they only have themselves to blame if they're 
>poor. The dispute that remains is just which 
>behaviours are most important, how you would 
>specifically change them, and what effects that 
>would have. But who can judge that best, and why?
>The Vatican went through 23 money-losing years 
>until 1993, but the situation improved 
>dramatically after a revised code of church law 
>made clear that dioceses around the world should 
>assist the Vatican. 
>Perhaps that is the way of the future for Barack 
>Obama in his likely future role of the "lender of the last resort".
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