Oil prices: supply = demand. Yeah right!

Going through supply and demand with some of my classes you cannot help thinking that sometimes the textbook isn’t that relevant.

If you have read Matt Taibbi’s book “Griftopia” you’ll have come across an example of how the theory of supply and demand doesn’t seem to work in modern times. In the book he talks about the amount of money invested in commodity indices – from 2003 to July 2008 the amount of moeny invested in commodities rose from US$13bn to US$317bn. Not surprisingly commodities on various indicies rose sharply during this time. Oil in particular rose significantly – from US$26 per barrel in January 2003 to US$149 in July 2008.

In May 2008 a top oil analyst at Goldman Sachs conceded that the increase in oil prices was without question the increased fund flow into commodities. The bizzare issue here was that oil supply was at all time high and demand was actually falling.

April 2008 – secreatry-general of OPEC stated that “oil supply to the market is enough and high oil prices are not due to a shortage of crude.” US data showed that oil supply rose from 85.3m barrels/day to 85.6m from the first quarter to the seconad quarter in 2008. At the same time oil demand dropped from 86.4m barrels a day to 85.2m. Furthermore around this time two new oil fields in Saudi Arabia and Brazil were about the start pumping vast amounts of oil. Some analyst stated that the increase in oil price was due to the security issues in the gulf but OPEC officials expressed the fact that not one tanker had been attacked and hundreds of them are sailing every day. Where were the lines at the petrol stations like after the oil embargoes and the Iran – Iraq war in the 1970’s?

The press came to the conclusion that the price increase was due to economic factors:

1. The nervous US dollar – investors were anxious about holding US dollars and prefered to hold commodities.
2. There was an increasing demand for oil especially the emerging nations like China

According to Taibbi, although both of these factors were real, it is very doubtful that they could have had such an impact that oil prices would reach US$149. Chinese consumption did increase – between January 2003 and June 2008 oil consumption in China increased by 992,261,824 barrels. However during the same time speculators bought 918,966,932 barrels of oil – according to the Commodity Futures Trading Commission (CFTC). By December 2008 the bubble had burst and oil proces plummeted along with the price of other commodities – oil was trading at US$33 per barrel. So now the process has started all over again. Will we see oil tankers just sitting in the gulf waiting for the oil price to go up?

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