Summary:
Daniel Gros (director of the Centre for European Policy Studies in Brussels) does believe that fundamentals are to blame for the rising crude oil prices, nor that speculators are driving the price up. It is the owners of the exhaustible resource which is oil that figure it is better to leave it in the ground, as they expect it will be more valuable tomorrow. Production will not increase because today's price is high, once producers expect tomorrow's price to be lower than today's. Equally, China influences the oil price not because of today's demand, but because the demand is expected to be even higher in the future. Another factor disincentivising producers are the negative real interest rates in the US, reducing the return from the dollars they would earn from increasing production. Oil producers are merely limiting their accumulation of rapidly depreciating dollars by limiting the rate at which they extract oil. If there is a bubble, however, it is not so much a bubble in the price of oil, but a China bubble, i.e. speculators and oil producers are gambling on China's sustaining high prices for ever. (Published: 09/07/08)
Notes:
- most economists:
- current sky-high price of crude oil is justified by fundamentals
- high growth in demand by emerging markets, i.e. China
- evidence:
- supply and demand seem finely balanced and inventories not increasing
- in spite of very high prices, production has not really increased
- Gros disagrees
- observation that inventories are not increasing is irrelevant:
- there is a very convenient way to store oil that is not measured by inventories data:
- just leave it in the ground
- observation that production has not increased is also irrelevant:
- does not take into account the nature of oil as an exhaustible resource
- owner of an exhaustible resource (e.g. King Ab-dullah, of SA) has to make a n inter-temporal choice:
- extract today or extract tomorrow
- extract today, get today's price (minus extraction cost)
- extract tomorrow, get tomorrow's price (minus same extraction cost) discounted at today's interest rate
- supply of oil today will thus increase only if tomorrow's price is low relative to the price today
- i.e. supply of oil will increase not when the price today is high, but only if suppliers expect that prices will be lower in the future
- implies that China influences oil prices today not so much because Chinese demand is high today
- but because demand in China is projected to increase so much in the future
- fuels expectations of higher prices
- leads producers to lower their rate of extraction today
- therefore: no mystery that oil supply has not reacted to higher prices:
- rational oil producers are just waiting for even higher prices tomorrow
- another factor limiting oil supply today:
- return to oil producers from the dollars they would earn from increasing production has over the past year been greatly reduced by the US Fed
- US interest rates are now negative in real terms
- therefore: rational for oil producers to limit their accumulation of rapidly depreciating dollars by limiting the rate at which they extract oil
- high oil prices are therefore at least partially a consequence of an expansionary monetary policy in the US
- need to listen more to the suppliers and less to traders on commodity markets to understand oil prices and production:
- King Abdullah: "If additional oil were to be found, I would advise leaving it in the ground because with the grace of God our children might have a better use of it."
- real culprit is the expectation that prices can only go up
- not the trading among speculators
- they are simply betting against each other so that one side's gain is the other side's loss
- regulating oil derivative markets might affect the amount of "speculative" trading, but it will not induce oil producers to increase production
- speculators not to blame = no bubble in oil market?
- not necessarily:
- a bubble starts when past price increases lead to expectations of future price increases
- it could very well be that prices will not increase as much as expected if China's future demand for oil is lower than expected today, or if alternative energy supply sources become as cheap as some suggest
- sky-high oil prices are likely to lead over time to a massive substitution away from oil, even in China
- happened after the first two oil shocks
- but: will take years for this scenario to materialize
- best explanation of oil prices is neither "bubble" nor "China", but a "China bubble"
- i.e. speculators and oil producers are gambling on China's sustaining high prices for ever
