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A couple of thoughts on oil

April 21st, 2005

he price of oil is stlll around $50, and there’s no reason to expect it to fall in a hurry. In particular, if China revalues the renminbi yuan, as is commonly expected, there will be a corresponding fall in the effective price of oil, both for suppliers and for consumers in China and other countries that revalue, for any given $US price. This probably doesn’t matter much on the supply side – everyone is pumping as hard as they can and will probably keep doing so. But China’s demand is probably quite price sensitive, and a reduction in the price could keep demand higher, even in the face of a slowdown in exports to the US.

The other thought that occurred to me relates to climate change. Although there are a variety of ways in which we could mitigate climate change, the simplest would be to double the price of carbon-based fuels. This would certainly reduce demand significantly in the long run (I’ll try and update this with some estimates soon). On the other hand, there’s a lot of concern about the short-run macroeconomic impacts of such an increase.

Well we’ve seen a doubling of oil prices, and substantial increases in coal and gas prices over the past few years, and any macroeconomic impact is undetectable amid the general noise. The cases aren’t perfectly comparable of course, notably

* the rising price has been driven by increased demand, not imposed exogenously

* the effect of rising market prices is to redistribute income to oil-producing countries, and increase trade deficits. This effect wouldn’t arise with carbon taxes and would be much smaller with tradeable permits

Still, the evidence is against the idea that higher energy prices would bring the economy to a grinding halt. Rather, the response so far seems to be a textbook case of orderly adjustment, as people gradually shift away from gas-guzzling vehicles, look again at energy saving options and so on. So far the response has been small, but over time (if supply declines and prices stay high) more substantial responses can be expected.

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  1. still working it out
    April 21st, 2005 at 08:04 | #1

    Can you clarify something? When you say

    “there will be a corresponding fall in the effective price of oil, for any given $US price”

    do you mean a fall in the price of oil only for the Chinese (and anyone else who revaluates) which would increase Chinese demand and hence put oil prices up in general. I think that’s what you meant, but it sounds like the opposite at first reading.

  2. John Quiggin
    April 21st, 2005 at 08:18 | #2

    If we hold the $US price constant, the effective price paid falls for Chinese consumers and others who revalue, and remains unchanged for others. The effective price received by sellers falls relative to a basket of trading partners that includes China.

    The presumed second-round effect, as you say, is that the $US price should rise, increasing the price paid by the US and others whose exchange rate with the US remains unchanged.

  3. still working it out
    April 21st, 2005 at 08:54 | #3

    That’s really interesting because Brad Setser and Nouriel Roubini have been saying that most of the rest of East Asia want to revaluate as well, or at least stop having to buy so much US debt but cannot do it unless China does first. Which means when China revaluates Taiwan, Korea, Japan and a lot of other Asian countries will do so as well. This could lead to a huge surge in demand for oil from throughout Asia.

  4. April 21st, 2005 at 09:12 | #4

    Pr Q seems to be saying that OPEC’s price gouging is equivalent to running a pilot program for greenhouse carbon emissions control. Who would have thought that a bunch of sheiks and oil-patchers were closet Greenies?

  5. John BIgnucolo
    April 21st, 2005 at 11:54 | #5

    OPEC members (modulo Iraq) are pumping as much oil as they can. In the case of Saudi Arabia it has meant pumping water into the Gwahir supergiant field to maintain production. The only member not pumping to capacity is Iraq.

    Well before the latest price increases OPEC members were pumping millions of barrels per day more than their nominal quotas.

    So is it price gouging when a supplier is operating at capacity but can’t meet consumer demand? It’s not the suppliers’ fault if consumers are willing to pay higher prices to ensure supply. I thought that’s the way markets worked?

  6. James Farrell
    April 21st, 2005 at 12:14 | #6

    If, as I suspect, the the pump price of petrol in China is essentially administered, the exchange rate appreciation won’t affect it much. Oil imports will still depend on what China can pay for with its exports. As far as I know China still only accounts for about three or four percent of global oil imports. So the exchange rate shouldn’t affect the terms of trade either.

  7. gordon
    April 21st, 2005 at 12:21 | #7

    Does Prof. Quiggin mean that he completely discounts the OPEC view that large recent price rises are at least partly speculative, ie. not entirely related to supply and demand?

    From the OPEC website: “…Yet both producers and consumers have acknowledged on many occasions that the market has been well-supplied in recent times, indicating that such prices are not justified given supply/demand fundamentals, especially considering that the build in crude oil stocks is now above its five-year average.

    But markets are markets, and it seems that nothing can stop oil from rising of late. Of course there are fundamental reasons for this, rational or irrational, but some of the more concrete factors are: a later winter in the northern hemisphere; unusually strong demand; and price pressure and volatility coming from the increased activity of non-commercials in the futures markets, exacerbated by continuing geopolitical tensions and bottlenecks in the downstream.” The URL for this quote is

  8. Katz
    April 21st, 2005 at 12:22 | #8

    Is it true that the prices quoted daily for oil established by traders operating on various commodities markets determines the price of a large percentage of oil consumed in the world?

    If so, does anyone have information or access to information about how the proceeds for the sale of oil on those markets are divided between the sellers of oil royalties (usually governments) the licensees (usually oil companies) and any marketing corporation that handles the sale of the oil to refiners and distributors?

    More precisely, to what extent are the sellers of royalties subject to either favourable or unfavourable changes in the price of oil?

  9. April 21st, 2005 at 12:40 | #9

    Oil companies are only finding about half the amount of new oil that they are producing. Demand is rising as China and India increase car use.

    Although people think that Peak Oil is a conspiracy theory it is a acutally a reality based on supply and demand.

    What will happen is that our resistance to change will force to continue to use oil until the last drop of really easy oil is gone. This is the plateau that Peak Oilers fear most – when we drop off this the could well be far reaching effect on the global economy.

  10. Steve
    April 21st, 2005 at 13:15 | #10

    One of the more obsessive-compulsive habits I have is to check the price of oil in various markets everyday at http://www.oilnergy.com. I have been watching it go up and down (mainly up) for about 1.5 years now. Sometimes they are a bit slow to update, so i also fairly regularly do a search on “oil” at Google News to find the latest stories on the price of oil.

    I don’t even work in the oil industry, so its a bit weird. but anyway….

    Here’s what I’ve noticed, and why I now treat almost any commentary/forecasting on the price of oil that I read in the mass media with a big grain of salt:

    1. Whenever the price of oil dips (even if it is only a drop over 1 day) away from a big price peak (eg. Oct last year, May last year, or March this year), commentators/analysts will all predict that they are certain we are now seeing an end to the ‘bull market’ for oil.

    2. There is ZERO consistency on what is causing the price of oil to rise. Some people say demand in china, some say unrest in venezuela, some say demand in USA, a cold snap in the USA, higher winter demand, the US ‘driving season’, the iraq war, sabotage in Saudi Arabia, need for new supply infrastructure, OPEC limiting supply, peak oil. If there is a commentator/analyst who makes more sense that the others, I haven’t found her/him.

    3. Most commentators are happy to analyse a change in the price of oil that occurs over 1 day. This seems ridiculous to me, esp when there are so many factors involved, and everyone is so uniformly unable to predict where the price will be going.

    4. One of Australia’s analysis groups who are supposed to be on top of this – ABARE – don’t seem to have successful predicted the price of oil correctly for… (not sure when they got it right). (not an exhaustive check, i admit). Early last year they were saying that oil might stay high ($28-$30, before settling down to an average of $22-23 by about now and until 2010. ie. ABARE are no better than anyone else at predicting the price of oil. Nobody seems to have foreseen the current high price, with the exception of the peak oil crowd.

  11. Steve
    April 21st, 2005 at 13:23 | #11

    Forgot to add: Please go visit http://www.oilnergy.com and check out the graph of the WTI price from 1978 to present at the bottom of the page. Tells a story.

  12. April 21st, 2005 at 17:07 | #12

    “to what extent are the sellers of royalties subject to either favourable or unfavourable changes in the price of oil?”

    Venezuela has just announced 50% income tax on oil producers. Chavez will be able to buy more replacements for his 50yo Belgian pea-shooters as oil goes up.

  13. April 21st, 2005 at 17:12 | #13

    .. and in other heartening news, the US has just voted for drilling in Alaska. And completely unrelated, the same august body has voted against requiring car makers to increase avg fuel economy to 33 miles per gallon over the next decade.

    Enders is right. Our resistance to change is our downfall here.

  14. April 21st, 2005 at 23:37 | #14

    Steve, rather on the stopped clock principle, they are bound to get the oil price right instantaneously if they only keep plugging away.

  15. Johng
    April 23rd, 2005 at 01:18 | #15

    The IMF has a very interesting article on oil in its latest World Economic Outlook. They try and predict demand by 2030 and come up with quite a large number. They argue that the demand elasticity for oil when there are moderate price rises is only .10. However you do get big falls in demand when there are oil shocks ie very large increases in price which over time lead to a burst of new technologies and redesigning which leads to significant demand reductions. An interesting hypothesis about markets for the IMF to embrace.
    ” The model finds that in both groups of countries,consumption of oil products is closely
    linked to the level of economic activity and vehicle ownership. These two variables in fact
    explain the bulk of oil consumption growth over
    time. In contrast, oil demand is fairly unresponsive to price changes as long as the level of real oil prices remains well below its historical peak—a 10 percent a barrel increase in prices reduces demand by only about 1 percent.
    However, large price changes, such as the ones
    experienced in the 1970s, have substantial—up
    to five times stronger—effects, in part because
    they can trigger a significant adjustment of technology and oil consumption.

  16. JN
    April 23rd, 2005 at 08:09 | #16

    Logically the proceeds of a carbon tax should be invested in renewables and not absorbed into general revenue. I don’t see the Howard government bringing in a carbon tax, quite the reverse; on TV we see service station proprietors complain about unfair fuel taxes and the Treasurer pleads for more investment in coal export terminals. This government pays lip service to greenhouse reduction but is ideologically incapable of meaningful reforms.

  17. Juke Moran
    April 23rd, 2005 at 12:00 | #17

    This is a comment to this post at CT, should be number 53 in the thread there, but two attempts vanished already. An act of cathartic venting.

    Artificial life imitates itself.
    David Soucher reframes the argument to an either/or – with Big Capital either causing or having nothing to do with making people feel they’re going to have a better shot at surviving whatever comes inside a big tough vehicle.
    The smirking b.s. that the zeitgeist arises spontaneously outside the dome of commercial propaganda is still a potent weapon, evidently. Even though most Americans spend their entire lives inside that dome.
    This same sidestep of culpability has been used to shield the perps who’ve driven the American public consciousness back into the third grade. A demonic rationalization of demonic seduction.
    We’re not talking about aesthetic differences – we’re talking about poisoning the well and then laughing about it. The alternatives are scary, but then so’s maintaining the status quo ante now, so everything’s scary.
    So here’s a bulwark for the frightened to cower behind. Two tons of steel and 300 horses, with backseat video and onboard GPS.
    That the barrage of advertising TV’s saturated in shows pristine natural landscapes dominated by shiny SUV’s – hey, it’s the zeitgeist! expressing itself!
    The devil speaks in his own defense to the galactic tribunal – “They asked for it! I just gave them what they asked for! It was what they wanted!”
    Seduction played no part in that, hmmm? Oh no. Not at all.
    The average American relies on merchants for an accurate picture of the world. Cars are the most important mercantile commodity in the US. No connection there, how could there be?
    Others may accuse Big Capital of something, not me. I don’t believe there’s any such thing, just a shape-shifting aggregate of amalgamated greed-heads who could as easily run slaves in a barter economy, though it’s quite possible there’s something behind them far more sinister. Maybe not, it’s hard to tell from here.
    But for sure the simplistic notion that current demand for SUV’s is just sui generis spontaneous desire, rising out of some inchoate striving after “cool”, is nonsense. Naive or cynical, but nonsense either way.-Cigarette smoking was pandemic in the US; then in the span of a few years it became socially repugnant.
    The same tools were employed to both generate and eradicate that particular expression of the zeitgeist’s appetite for “cool”. And it’s still taboo to look behind the curtain to see how it was done.
    There is a curtain, though. A big one.

    MW – I haven’t been on an airplane since 1991, when I flew into Seattle from Europe – and man, I tell ya, my arms are still tired!

  18. Andrew Reynolds
    April 23rd, 2005 at 23:27 | #18


    Try correcting that graph for inflation and you get another story entirely. This link covers it nicely, but I will look for a better one.

  19. Steve
    April 25th, 2005 at 13:35 | #19

    THanks AndrewR, yes, that was a good article.

    I know the story in the graph I posted is exaggerated, since it doesn’t account for inflation, or for more robust world economies and more fuel efficient vehicles.


    I think it is still noteworthy the way price has bounced up since the year 1999. The increase in prices since is quite stark against the relatively consistent price from 86 to 99 (gulf war I aside).

    When you go and look for the reasons for that post 99 increase, and for last years increases, you get a lot of answers.

    Also, wrt the article you linked to, I did find the tone of it a bit too alert not alarmed. I think a little bit more alarm is perhaps ok, given
    *the rate and magnitude of increase in price over the past year
    * some commentators have mentioned $100 a barrel – higher in real terms than prices in the 70’s oil crisis.
    * the level of uncertainty evident in this quote from the article you linked: “At S&P, we still expect oil prices to drop into the $35 range over the next two years, but we wouldn’t be surprised if prices go up instead.”

  20. Steve
    April 26th, 2005 at 20:34 | #20

    Here’s a graph of inflation adjusted oil prices since 1946.

    Does tell a very different story. Still, the price today is equivalent in real times to the price during the 70s, and the price during gulf war I, but much lower than the early 80s spike, which is about $95/barrel in 2005 dollars.

  21. Steve
    April 26th, 2005 at 20:37 | #21

    And here’s the same inflation adjusted graph, but also indicating when recessions occurred.

  22. May 7th, 2005 at 23:22 | #22

    sounds like a one-off in a particular oil reservoir – but the survivalist website is certainly well-stocked – seems to be a bottomless well itself – I’ll be returning there next armageddon

  23. May 9th, 2005 at 14:08 | #23

    Its a scam. Think about if oil wells could refill the planet would be awash in oil. I don’t think that they will refill at the rate of 80 million barrels a day.

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