Energy
Cost of oil
What's behind today's high prices?
Last Updated: Tuesday, July 8, 2008 | 3:08 PM ET
by Dan Westell, CBC News
The daily ups and and downs in the price of a barrel of oil are the outcome of a titanic behind-the-scenes struggle.
The "nodding donkey," used to pump oil from conventional fields, is the universal symbol for oil production. On one side is rising demand, especially from India and China, and shrinking supplies. Those two factors, perhaps seasoned with speculative trading by hedge funds, will inevitably push prices up, adherents of that position say.
On the other side, there is a group who believe that the flagging world economy will cut demand, causing prices to steady or even drop.
The big five Canadian banks span the debate. In July 2008, the Royal Bank predicted oil will fall to $90 US a barrel in 2009, down from a high of more than $145 early in the month. That was soon after Jeff Rubin, chief economist at CIBC World Markets, boosted his oil-price forecast to an average of $150 a barrel for 2009.
The other three big banks fall between those extremes, with two closer to the Royal Bank and one in CIBC territory.
The price and perceptions about oil matter because the economy runs on oil. Higher gas prices have slashed sales of pickup trucks, causing automakers to close the plants that make those vehicles. The tourism business fears vacationers will drive less as the cost of doing so rises. Transit systems report more users as gas prices go up, and the price of goods that move on trucks or trains — that's just about everything — is going up to cover higher shipping fees.
In the richer countries, oil prices are boosting inflation, which worries central banks. Their response is to raise interest rates to cool off the economy. That hurts — as it's meant to: combined with higher energy prices, the rate hikes force companies to cut production, reducing growth and increasing unemployment.
The G8 industrialized countries are worried about the oil price surge. At their July 2008 meeting, they called on producers to open the taps and, almost as an afterthought, suggested that improving efficiency to reduce demand would be a good idea, too.
But a rough adjustment for rich countries is a disaster for the world's poor. Current prices "have become a threat to the global economy and social welfare of millions of people; some are calling it the third oil shock," Nobuo Tanaka, executive director of the International Energy Agency, said in July. For some of the world's poor, higher fuel prices have led to a dire choice: eat or travel, media reports say.
More than supply and demand
Tanaka thinks that oil prices are not likely to fall much soon. Supply, demand and limits on refinery capacity "will maintain pressure in the market over the medium term," he has said.
Alberta's oilsands, along with conventional supplies and projects off the Atlantic coast, are the focus of Canadian oil production.
(Adrian Wyld/Canadian Press) But there are many other factors in play in setting oil prices, including currency changes and, perhaps, speculation.
Like Tanaka, Chakib Khelil, the president of the Organization of Petroleum exporting Countries (OPEC), is predicting a higher price. But he sees the U.S. dollar as the problem.
As the dollar falls against other currencies, a barrel of oil priced in the U.S. currency costs more. Moreover, the money managers who move huge amounts of money around in world markets are always looking to protect their assets and make a good return. As the dollar weakened, some analysts believe money flowed into oil — and food, and gold, and other hard assets — as a hedge against the loss of value.
This flow raised the price, if it's real. And what looks like a smart investment decision to some is speculation to others. As such, controlling the flow of cash into oil is seen as a good thing.
Those who think speculation is causing an oil-price bubble include the government of Saudi Arabia, the world's biggest oil exporter, and George Soros, the billionaire who made his fortune in speculation.
The Saudi government in 2008 said speculators have contributed to prices "that are unjustified by market fundamentals." And Soros told CBC that institutional buying of commodities exaggerates price moves.
But the U.S. government position is that suppliers need to produce more to keep up with surging demand. "There is no evidence that we can find that speculators are driving prices," U.S. Energy Secretary Samuel Bodman said in June.
Without actually criticizing speculation, the G8 did back a study of the "real and financial factors behind the recent surge in oil and commodity prices, their volatility and the effects on the global economy."
Back in the good old days
Oil prices were stable for most of the 100 years before 1973 at well under $5 a barrel. Expressed in today's dollars, discounting inflation, the price was closer to $10 a barrel, hitting highs of about $15 and lows of close to $8.
Even as the world economy boomed in the decades following the Second World War, prices remained fairly stable. That's mainly because the United States dominated the oil industry — and the U.S. government regulated the price of oil.
From 1958 to 1970, the price (in real dollars) declined to below $12 per barrel from above $15. But in the early 1970s, the situation changed. OPEC had become a force, and in 1973, the first major oil shock hit the world as Arab nations refused to sell to countries that had expressed support for Israel in the Yom Kippur War of October 1973.
Within a few months, the price climbed from around $10 a barrel to $40. It was a huge increase, and the impact on the global economy was devastating. By 1979, the world was in for another oil shock as unrest in Iran led to the toppling of the Shah — a friend of the West — and the rule of the ayatollahs. Oil went from about $40 — again in today's dollars — to $80.
Over the next few years, the price of oil crashed. OPEC continued to pump it out but underestimated the severity of the economic recession of the early 1980s and the resulting collapse in demand. Oil prices dived to just over $20 a barrel.
The price fluctuated through a fairly narrow band, spiking again at $30 when Iraq invaded Kuwait in 1990. But after the 1991 Gulf War, the price again headed south, hitting a low of close to $10 in the late 1990s.
Since then, the price has been going up steadily, except for a brief dip after the 2003 U.S. invasion of Iraq ousted Saddam Hussein and created the expectation that the war there would be brief.
So in the summer of 2007, when prices spiked to $75, forecasters were making extravagant predictions: oil might hit $100 a barrel in 2008. That came with the New Year; on Jan. 2, 2008, a barrel fetched $100 for the first time.
Looking back from the $145 a barrel seen this July, with some forecasts predicting higher prices, last year's extreme forecast looks like this year's fantasy price.
