Volatile Oil Prices a Byproduct of Demand or Lack of Alternative Sources?Published: September 08, 2011 in Knowledge@Emory
The recent dip in gas prices in the US may have made the labor day weekend celebration a little brighter, but analyst warn the price break is not likely to last. Faculty at Emory University’s Goizueta Business Schoolagree, noting that even if the unrest in oil producing nations calms, gas prices are likely to trend higher.
“Events in the Middle East have exaggerated the price rises,” says Goizueta chaired marketing professor Jagdish Sheth. “But they’re not responsible for the longer term rise.”
The major cause for the fluctuation in prices is due to the comeback in manufacturing, he notes, citing the most recent Institute of Supply Management Report on Business, which indicates that “economic activity in the manufacturing sector expanded inAugust for the 25th consecutive month, and the overall economy grew for the 27th consecutive month,” in the U.S. through August.
“Manufacturing is also growing in Germany, India, and especially in China where ambitious public works projects are driving an intensive need for energy,” Sheth adds, while rising worldwide demand for consumer electronics, pharmaceutical and chemical products are also spurring a rise in energy costs.
“Pharmaceutical and chemical products are heavily petroleum-based, while many plastic and other components in PCs and smart phones also draw on petroleum products,” he reports. “Oil is the ultimate raw material—everything else from agricultural to fragrance products all represents value added activity.”
U.S. energy conservation activity is likely to have a limited impact on oil usage since the demand is global, Sheth notes. Despite that, the U.S. may be able to exert some downward pressure on pricing.
“America is still a leader in strategic assets like oil exploration and processing technology,” he explains. “If the federal government treated this competitive advantage the way it governs arms shipments, we could offer long-term contracts to oil producers in exchange for long-term price and delivery contracts for oil.”
The U.S. is also a leader when it comes to building refineries, and “it can insert itself as a nation downstream, offering its knowhow in exchange for long-term contracts at fixed prices,” according to Sheth. “We can also offer military technology against insurgents who attack oil pipelines and other assets. Finally, as a quick, but limited solution, the U.S. can build up its strategic reserves and release them as needed, much as the Federal Reserve tweaks the money supply by releasing or withdrawing funds in response to specific situations. Of course, it’s a lot easier to print money than it is to get oil.”
Goizueta assistant finance professor Ray Hill says the current price spikes stem from concern about the turmoil in Libya and other countries, rather than any significant changes in world oil supply.
“Some Libyan shipments have been disrupted, but they amount to less than one percent of world daily consumption,” he observes. “Fear of more significant disruption in Libya and unrest spreading to other big producers like Iran has certainly led to speculative pressure on oil prices.”
“If political events in the Middle East do not lead to any cuts in production, (an important ‘if’) then the speculative price increase will be temporary,” according to Hill. “Unlike gold, oil is dirty and bulky so it is difficult to store. Speculation cannot drive oil prices for very long. Notwithstanding all the talk of financial speculators ‘driving’ the market, spot market demand and supply for physical oil must clear the market every day."
He says tapping the U.S. strategic oil reserve, as President Obama has done, is a bad idea.
“Why should we make ourselves more vulnerable to a truly strategic interruption in oil supply (as we had in 1973) by using the reserve to counteract a temporary increase in price?” Hill asks. “And if events in the Middle East result in persistent cuts in production, rising prices may mean some unpleasant shocks to the economy in the short run, but long-term they’re likely to spur searches for new, more effective methods of extraction and usage, not to mention efforts aimed at establishing alternative energy sources. Releasing oil from the strategic reserve blunts this important price signal to the market.”
If the US wanted to put downward pressure on oil prices, it could ease its restrictions on drilling in its off-shore waters like the Gulf of Mexico, he suggests.
“However, the effect of easing these restrictions would probably not show up in oil supply for some time so it would not be an immediate antidote,” he adds. “And, of course, there are environmental concerns which must be taken into account as well.”
Apart from the spikes in prices driven by political events, the global economic recovery will drive demand higher and continue to exert so pressure on price increases over the longer run.
“Energy prices have tended to rise in the long run, but we’ve seen a lot of bounces down as well as up during the past 30 to 40 years,” he observes. “The fact is that people are bad at forecasting this trend, and no one can say exactly where prices will be ‘x’ years from now.”