Oil Prices

OIL PRICES….Dan Drezner is surprised that oil prices rose yesterday. After all, shouldn’t the Iran NIE have reduced the chance of military action or additional sanctions against Iran, which in turn should have reduced political uncertainty and thus the “risk premium” built into the price of oil? Dan brings up and dismisses three possible explanations for this paradox (traders are really dumb, traders have better intel than the CIA, Bush is going to bomb Iran anyway) and ends up with this as the only one left:

Political factors are not as important in influencing oil prices as some commentators believe.

Dan says this explanation “seems inadequate to me,” and it’s worth noting that a single day isn’t enough to draw any conclusions in a volatile market like oil futures. Let’s wait at least a week to see what the fallout from the NIE is.

That said, I’ve long been skeptical of the conventional wisdom that the current risk premium built into oil prices is on the order of $30 per barrel. My own guess is that the real figure is $0-10. After all, demand is up and prices are way up, and yet production isn’t. This is very peculiar if there’s really any significant amount of spare pumping/refining capacity left in the world. Occam’s Razor suggests to me that the real answer is that spare capacity is close to zero and that’s why prices are going up. Political risk might play a role too, but I’ll bet it’s a fairly small one.

As always, this kind of speculation applies only to long-term trends. Whether the price of oil will plummet or skyrocket tomorrow is a game for commodities traders to play. But I’ll be pretty surprised if the nominal price of oil doesn’t increase 50-100% by 2010.