Saturday, May 30, 2009

Oil is creeping back up.

. Saturday, May 30, 2009

Gas prices have increased by 20% over the last month (and jumped 90 cents since January), and the price of a barrel of oil has more than doubled since February closing at $66.31 at the end of trading on the NYMEX on Friday afternoon. With the daily news cycle fixated on the appointment of Sonia Sotomayor to the U.S. Supreme Court, the erratic (but, not really) actions of the DPRK and their recent nuclear test, Susan Boyle coming in second on Britain's Got Talent, and of course Prince Harry visiting New York City on his first official U.S. visit, the talk of increasing oil prices has been relegated to the back pages barely getting attention from policymakers and the media. 

This increase comes at a pretty bad time for most Americans. With the unemployment rate hovering at about 9% and the much anticipated summer driving season getting underway, a steep rise in the pump price of gasoline may put a dent in summer vacation plans and family budgets. Granted, oil prices are still half of what they were last summer when they peaked somewhere in the $140-150 a barrel range. But with American families feeling the pinch, a 20% increase in gas prices, especially in only 31 days with future increases expected throughout the summer, may cause Americans to cut spending even more than they already have. 

Analysts were expecting the low cost of gas to provide an incentive for families to hit the road this summer, thereby providing businesses with a stimulus of sorts. The expected increase in spending may not happen, at least not to the level that was expected, which may threaten the slim hope for a recovery beginning in the third quarter. Francisco Blanch, energy strategist at Merrill Lynch, said crude prices are nearing levels where "they could put the embryonic economic recovery at risk." 

"There's way too much optimism about a driving season lift," said Tom Kloza, chief oil analyst for the Oil Price Information Service, who believes that higher prices, in conjunction with the recession, will dampen the typical summer travel surge. Kloza said the impact will be especially painful in economic "sore spots" like California, Florida, Arizona and the rural South.

So, why have prices jumped so much lately? Well, OPEC announced further output cuts a few weeks ago but decided not to touch production at it's most recent meeting, although not all member countries are complying with the aforementioned cuts. These cuts are having an impact on oil prices, although the impact may be less than most expect because of the cheating going on. US supplies have dwindled recently, a sign that demand may slowly be increasing. (We know how this supply-demand function affects the price of oil. For PoliSci and Econ students, see Oatley's IPE text or Krugman and Obstfeld's International Econ text for an in depth explanation.) 

There is also talk from analysts and politicians of increased speculation in the oil market as of late. Bernie Sanders of Vermont is calling for federal regulators at the Commodity Futures Trading Commission to crack down on speculators arguing that "rising oil prices during a global recession, while demand has eased, is a very unusual moment. There is more oil sitting around than ever before, so there is no supply problem. U.S demand is the lowest it's been in at least a decade. What we are looking at now is not the fundamentals of the economy. What we are looking at is speculation on Wall Street."

The flip-side to this argument is that these ups and downs in the oil market are simply market reactions to future expectations. Expectations of increased future demand may be driving the increases in oil prices, which is to be expected if you believe the recent words of Summers and Bernanke and the talk of the beginning of a recovery in the third and fourth quarters of 2009. (Although I will point out that the definition of a recovery varies across academia and the policy world.) Most see recovery as merely the return of economic growth even if growth is painstakingly slow (somewhere in the .1-.2% of GDP region). This slow positive growth may not justify such a dramatic increase in oil prices. As always, the best explanation combines all of these factors and describes the rise in oil prices as a function of creeping demand, dwindling supply, market expectations, some speculation, OPEC output cuts and even the political environment in oil-producing states. 


Oil is creeping back up.
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