Here is a line of thinking that I have heard several times recently – oil prices have increased so rapidly recently that the market has become overheated and will pop like a bubble. Comparisons to Dutch tulips, Dot Com stocks, and housing prices abound on TV, on the radio, on the web, and around water coolers. There is one major difference that causes me some grave concern – oil, unlike all of those other investment manias that exploded, is a commodity with visible, experienced hands on the controls.

The reason that I am concerned is that I believe that high oil prices are hurting nearly everyone and the pain will increase as time goes on. The hands on the controls, however, are feeling no pain.

The Organization of Oil Exporting Countries (OPEC) is an internationally recognized cartel established in September, 1960 that holds well publicized meetings on a regular basis to discuss production allocations that are specifically designed to maintain a market price that members agree best meets their internal and external needs. Many of the country representatives to that meeting have spent lengthy careers thinking deeply about oil prices and how best to manage them to benefit the people who send them to the meetings and pay their generous salaries.

Oil market controllers have experienced a number of ups and downs and worked diligently to master the many price influencing tools at their disposal. Those tools may be a bit blunt, but they can be effective if wielded with skill by experienced manipulators. OPEC supplies about 40% of the total world’s oil and has an impact that is disproportionate even against that large total. Its decision are closely watched and often widely respected by large suppliers that are not members. All oil suppliers recognize that they have a very special commodity that responds to even tiny differences between daily supply and daily demand.

During the decades that I have been interested in energy as a study topic, I have heard or read hundreds of reports in oil industry trade publications that indicate the respect given to OPEC as a disciplined cartel that does all suppliers a service by keeping prices at profitable levels.

Though traders can store oil, the volume of daily consumption is so vast that even a 1% over supply situation can fill up storage areas in just a matter of months while a 1% deficit can result in significant shortages in some locations. Like a hot air balloon, there is a potential for a disastrous crash with an inexperienced or poorly coordinated crew, but there is also the potential for a very pleasant ride for those who know what they are doing.

Unfortunately, the basket under an oil fed hot air balloon is not very large and the number of people who benefit from an oil price balloon that never comes back to earth will be rather small. I see few prospects, however, that those of us left on earth will be invited to share in the benefits of the ride any time soon. It is way too much fun for the people in the basket to collect massive quantities of money from the rest of us who seemingly have no means of forcing that balloon to return to earth.

Recently, an oil minister from an OPEC member told the world that his country saw no reason to increase supplies since demand destruction was already working to put supply and demand into balance and a Russian oil and gas executive gleefully predicted that oil prices would reach $250 per barrel in 2009.

At my own water cooler, the objection that I get to my line of thinking is that oil prices experienced a collapse during the mid 1980s and remained low for about 15 years. They tell me that proves that a period of high prices will almost inevitably be followed by a period of low prices caused by the combination of new supplies encouraged by high prices and reduced demand caused by a reaction to the high prices. Their interpretation of oil price history is that the conservation efforts install a long term change in consumer habits. Apparently they think that OPEC recognizes this and will reduce prices in time to avoid a long term loss of market share.

The difficulty that I have in accepting this interpretation is that low energy prices through the 1980s and 1990s were driven not by a reduction in demand, but by a relentless increase in the available supply of useful energy. Most of the new supply came into the market from sources outside of OPEC.

Total energy use did not fall after the oil shocks of the 1970s, but the annual rate of increase slowed. Total supply actually increased substantially as new production areas like the North Slope of Alaska and the North Sea came on line at the same time as new nuclear power plants added the energy equivalent of 12 million barrels of oil per day to the world supply.

Today there are no major production areas that are beginning operation and there are not any massive new nuclear plant programs with plants ready to connect to the grid. The time delays required under current laws are going to make it difficult to change supply rapidly enough to make much difference for at least a few years.

We are in for a long slog of high prices – unless the world’s political leadership takes action to enable massive new supplies to reach the market more quickly than is currently predicted. Jawboning might just work, but it is a long shot. It just might be that the balloon will remain aloft for a long time without popping or even leaking very much.

Photo credit:Hot Air Balloon – used under Creative Commons license from aoife mac

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