Oil Prices

OIL PRICES….Over at Morgan Stanley, Eric Chaney and Richard Berner are perplexed that oil prices haven’t gone down. The reason for this strange state of affairs? High demand and low supply:

New data from the February International Energy Agency (IEA) report show that global crude demand was 0.2 mb/d stronger than previously estimated in the last quarter of 2004 and that crude supply was slightly lower than prior data indicated.

….Unfortunately, however, there’s more to the supply story: non-OPEC producers are operating at full capacity and output is stagnant….Moreover, with no increase in refining capacity yet visible, we are concerned that the onset of the US summer driving season will push product prices back to previous highs and crude prices could well follow.

In hindsight, it appears that OPEC was literally operating at full capacity in the fourth quarter of last year, for the first time ever.

James Peltz echoes this in the LA Times today:

Oil prices are trading at lofty levels because global supplies of crude are stretched thin, while the world’s thirst for oil ? especially in the U.S. and China ? keeps climbing steadily.

The only thing that perplexes me about this is why these guys are all so perplexed. It’s true that short term prices are volatile and can easily go up or down for short periods based on strictly temporary conditions. But the basic picture is simple: demand has been growing faster than supply for over two decades, and today there’s virtually no spare production capacity left in the world ? even in OPEC. Unless something dramatic happens, demand will permanently outstrip supply sometime in the next few years. In the meantime, prices will continue to rise and will continue to be highly sensitive to even small production problems.

More details are here in this post from last year, including some thoughts on what to do about this. There’s no way to reliably predict the supply and demand of oil six months from now, but the picture six years from now is considerably clearer absent some stunning technological breakthrough. The fact that everyone seem freshly surprised about this every time gas prices go up a dime is truly mind boggling.

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