Oil: When the Zen Masters of Economics fail us...

I've spent some time thinking through the current economics of Oil - and with all the experts coming out recently - it's easy for a normal person to be perplexed by the situation.  Some say it's OPEC and they need to produce more.  Some say it's consumers and they need to consume less.  Some say it's all about the US and love of the SUV.  Some say it's the commodities market and how money has shifted to oil speculation.  Some say it's the instability within the oil producing region [whichever region you happen to be talking about].

Lots of finger pointing, lots of "likely" answers, but little real evidence.

Now, it's true about SUVs or big cars that get less than 20 MPG - they use more gas to move people down the road.  And if you're the only one riding in that vehicle, then you are effectively "wasting" fuel - because one person can ride in a smaller car and get from point A to point B just as efficiently.  But, on the other hand, if you have several people in the same vehicle, then the effective MPG goes up [Distance Driven x People in Vehicle / Fuel Consumption = Effective MPG].  So, for the time being, lets just say that SUVs are not the reason for the high price for gasoline.

So how about Supply?  Well, if you look at the historical numbers, supply has stayed rather constant with the ebbs and flows of demand.  Macroeconomics tells us that there is a relationship between the Supply [in this case, barrels of oil pumped out of the ground] and Demand [simply, gasoline - but there are lots of other products produced from crude oil].  That is there more supply than demand, we have a surplus and prices go down;  if supply is lower than demand we have a shortage and prices go up.  In the case of crude oil, supply has basically tracked with demand - so really neither is the case from a macroeconomics perspective - you have to say it is in "balance".

So what about Demand?  We all know there is a "thirst" for Oil.  The world has gotten used to having a very cheap source of energy [no matter how inefficient it really is].  And we use this raw material in thousands of ways - with Gasoline being the most "visible" to the consumer.  But has demand [worldwide] risen so much that the price should be so high? Here are couple things to consider...

1.  The United States consumes approximately 25% of the world's oil supply - that is a fact.  70% of our consumption is based upon "foreign oil" - another fact.  What is not so well known, is that our average daily consumption has remained fairly flat over the past 5 years.  Now considered we just came out of a fairly robust economic expansion [about 5% growth per year], but our consumption remained flat [increased just at 1% over five years], means that we in reality are consumer "less".  So, is the US actually to blame here?

2.  The developing nations - mainly China and India - have grown their average daily consumption, but at about 1/2 the rate of their economic expansion.  So in reality, they have a "decreasing" demand for oil also.

3.  Overall, the demand for Oil can be considered "flat" in relationship to the worldwide economy.  Which is interesting because we keep hearing how DEMAND for OIL is driving the PRICE UP.  But the facts [at least those I've seen] don't support that argument.  Because demand alone, does not cause the price to go up - it has to be accompanied by a "supply" problem - but all the facts are saying supply has historically tracked with demand.

So what is it?  Why has the price for oil risen so fast over the past 18 months?

Well - if Supply and Demand is not the problem, then it has to be something else.  Not necessarily - Supply and Demand are "theories" of economics, they are not LAWs of Nature.  But for those two forces to have an effect on price, there has to be some "variable" from a consumption.  But as we have witnessed, a rising price has had very little affect on Demand.  So, even though we complain about the high price of gas [and have over the past couple years], we still drive as much as we did two years ago.  So, possibly, price has nothing to do with supply and demand - possibly, there are no alternatives or substitutes for OIL and no matter what the price, we are will to pay it. 

I'm going to think through this a little more -- and provide some other interesting facts [maybe] and opinion [definitely].