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Ways of the World

Carol Stone, business economist & active Episcopalian, brings you "Ways of the World". Exploring business & consumers & stewardship, we'll discuss everyday issues: kids & finances, gas prices, & some larger issues: what if foreigners start dumping our debt? And so on. We can provide answers & seek out sources for others. We'll talk about current events & perhaps get different perspectives from what the media says. Write to Carol. Let her know what's important to you:

Tuesday, March 08, 2011

Oil Supply & Demand Put Us on Tenterhooks Once Again

Regular gasoline sold for a national average of $3.52 last week, according to Department of Energy data reported Monday. The increase for the last two weeks was 33.1 cents, the second largest increase ever over a two-week span, with only the spurt during Hurricane Katrina larger. The $3.52 price is 28% above a year ago and a record for this time of year; even in the high-priced period of 2008, the level around March 1 was right at $3.15.

Such a surge, plus increases in food prices, pose dilemmas for policymakers in the U.S. and in a number of those Middle Eastern and Asian countries, as well as discomfort for the people who have to pay them. Clearly the Mideast turmoil is responsible for the sudden, large energy price gains. But these prices were already headed upward to some extent, having started the current uptrend at the end of last September. So there must be some other force at work on both energy and food prices. We'll save food for a "part 2" article and continue here with the steep oil price rises.

Besides the Mid-East violence, two non-political causes for these price advances are readily identified. One is the very fundamental demand/supply balance: world demand is growing and exceeds supply. Second, many express concern that inflationary monetary policies are contributing to the upward push in the prices of these basic necessities of life. The connection here is hard to measure, but there may be some justification for it.

A new study by economists at the International Monetary Fund (IMF) published just in January explores these two connections, supply/demand and money, for oil prices. Cevik and Saadi Sedik performed statistical analysis to assess the impact on crude oil prices of demand growth in the world economy, over against growth in the supply of oil; they also try to gauge the impact on prices of the amount of money in the world economy as generated by four major central banks. They represent energy demand by growth in industrial output in 45 countries, which they place in two groups, developed and emerging.[1]

The results of Cevik and Saadi Sedik's statistical regression calculations are very interesting. Using monthly data, they show that since 1998, oil supplies have had some influence on oil prices; as supplies expand more, prices tend to decline, although the magnitude of the decline can be quite variable. The amount of money available for use in world trade and finance is related positively to oil prices; as excess liquidity increases, so do oil prices. Again, though, this relationship, though, is subject to considerable variability through time. Much more significant as a determinant of oil price trends is demand growth in the various countries; moreover, demand in emerging markets has more than twice the measurable impact of demand in settled industrial countries, and the reliability of the emerging market relationship is much tighter than the supply and monetary relationships.

We would think probably that demand in big countries should lead because they simply use more oil, lots more. But they are also working hard to conserve it. In the U.S., for example, the current rate of petroleum usage is just under 19.2 million barrels a day (b/d, a barrel contains 42 gallons), down from 2007's peak of almost 21 million b/d. The International Energy Agency estimates that demand among advanced countries as a whole has receded to about 46.5 million b/d in the latter months of 2010 from a peak of 49.3 in 2007. By contrast, the I.E.A. estimates that China's usage in the fourth quarter of 2010 was 10.0 million b/d, more than 30% greater than 2007's 7.6 million b/d. Demand among other developing countries is up over that period by about 10%. Further, most of these countries' economies did not suffer a recession, but continued to grow in 2008 and 2009. These numbers alone, even before we get to Cevik and Saadi Sedik's statistical analysis, highlight the rapidly expanding importance of the developing countries in energy markets.

The longer trends from 1998 through the middle of 2010 tell a fine story that growing prosperity in emerging countries is pressuring energy prices. But obviously the very short-term situation now features near civil-war conditions in Libya. How does this complicate our lives? Just yesterday, Monday, March 7, the Energy Information Administration of the U.S. Department of Energy gave us some comments toward an answer in their article, "Libyan supply disruption may have both direct and indirect effects"[2].

First, while Libya's crude oil output is just 2% of the world's total, the oil they do have is among the highest quality stock. It is easy to refine and has low sulfur content. Energy Department specialists explain that this means almost any refinery in the world can process the oil; its treatment is not restricted to only the newest or most elaborate facilities. Such oil is not easily replaced by substitutes, such as Saudi Arabia has. Libya also sells to customers in both Europe and Asia. Italian refineries buy Libyan crude and make a number of derivative products to sell to an even broader customer base. So the near shut-down of Libyan production can put more pressure on refinery inventories and prices than would constrained supplies from other regions.

Somewhat offsetting this push in the short run, this late winter season is a time of relatively light oil usage in both the U.S. and Europe, the Energy Department underscores, and the disruption in Libyan supply has a lesser impact than it would in late spring and summer. Should the disorder last well into the spring, when refineries will gear up for the large volume of summer driving, that could intensify pressure on supplies and make prices go higher still.

So where do these forces leave us? Briefly, on tenterhooks. The danger to the world economy of this price surge is readily apparent. Still, just in these last hours as we been writing here, we see from Reuters news service and other news sources that Mr. Gadhafi and his supporters may be trying to arrange an "exit strategy". This news accompanies announcements from several world oil companies that they are ceasing the purchase of Libyan oil altogether, thereby cutting off the country's income, which may hasten a resolution. Also, other OPEC nations have expressed willingness to provide extra oil to world markets, to the extent they can substitute. So there are constructive signs in the midst of the turmoil.
Two final thoughts: in this mix of wildly swinging world events, we continue to be heartened by the onrush toward freedom of the peoples of these countries and the repeated indications they are breaking out of repression and poverty. And then, we repeat one of our recurring Ways of the World themes and apply it to these energy prices. The higher prices are not totally harmful. They can provide extra wherewithal for people and companies to develop technologies that make better, more economical use of these raw materials. These are technical and technological issues; we can work on them. Better days are coming, we assert – hopefully.

[1]Serhan Cevik and Tahsin Saadi Sedik. "A Barrel of Oil or a Bottle of Wine: How Do Global Growth Dynamics Affect Commodity Prices?" Washington, D.C.: International Monetary Fund. Working Paper No. 11/1. January 2011. The paper also discusses supply, demand and monetary factors as they affect the price of a bottle of fine wine. The numbers are different, but the shape of the relationships is the same as with oil The emerging markets are indeed beginning to play discernible roles in world business.

Libyan supply disruption may have both direct and indirect effects. Washington, D.C.: U.S. Department of Energy, "Today in Energy" March 7, 2011. Accessed March 8, 2011.



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