FMC Blog: Free Speech Zone

The Price of Oil

No topic is more misunderstood than the price of oil and the oil industry in general. Most politicians and writers, who comment on the recent rise in the price of oil, its causes, and implications, simply have no clue what they are talking about.

The world is not facing an oil crisis and the price of oil is not exclusively determined by OPEC or any other organization or cartel. Today, every major oil producer, whether in Europe, the Middle East, Asia, Africa or America can influence the price of oil.

The point of this article is that the United States is not facing a crisis, nor is it addicted to oil and the United States government should allow the free enterprise system to responds to higher prices rather than politicians or government bureaucrats who don't understand the energy market.

It should be noted that this is not the first time the world experienced high oil prices. The world initially experienced a sudden increase in oil prices in 1973 and again in 1981. As a consequence of the rise of oil prices in the 1970s and early 1980s, oil production became profitable all over the world and every country that had the ability to produce oil raced against time to increase production and explore for oil. By 1985, world oil production had increased so much higher than demand that the price of oil simply collapsed and the world experience approximately 20 years of dirt cheap oil prices.

As a result of cheap oil, production and exploration naturally decreased because available oil supply was substantially higher than demand and producing additional oil was not economically feasible.

Then China, India and Brazil, among other countries, decided they no longer wanted to be poor. China's economy has grown at a phenomenal and unprecedented 10% annual growth for 10 straight years. At no point in modern history has a large nation experienced such consistent and explosive economic growth. Add India to the equation and within a short period of time two impoverished nations with 2.6 BILLION people were suddenly able to put down their bicycles and pick their car keys. Predictably, demand for oil and other natural resources increased substantially.

Within a short period of time, India and China went from exporting oil to becoming major oil importers. Consequently, the excess global oil capacity, which once numbered eight million barrels per day, was reduced to two million barrels per day. That is correct; the world is still producing more oil than demand for oil. However, because supply is only slightly higher than demand, the market is constantly on edge. Thus, news of Hurricane Katrina, rebels in Nigeria or the nuclear dispute with Iran tends to make the market nervous because several nations produce more than two million barrels per day and the fear that anyone of them may face a disruption keeps the market on edge and invites speculators to invest in oil in the hope that demand for oil may rise faster than supply or a disruption in supply would push prices to the sky in which case, investors would reap enormous profits.

The problem of oil supply has been exasperated by western nations, including the United States, who refuse to allow drilling for additional oil. The refusal to allow additional drilling is interfering with the free market system from efficiently responding to high oil prices. It is absolutely irresponsible for the United States government to prevent the oil industry from producing oil anywhere and everywhere that oil maybe found and produced in an environmentally sound way.

Some argue that allowing additional drilling will only produce one million barrels of oil per day. (As if one million barrels of oil per day is insignificant.) What those people don't understand is that it is not the amount of additional oil the United States produces that counts; it is the amount of additional global capacity that makes a difference. Thus, one million additional barrels in the United States, one million in the Middle East and one million in Latin America will make a huge difference when added together if the end result is substantial excess oil capacity. Even if substantial excess capacity is not possible, continuous exploration and production is necessary to keep up with the additional demand from China and India. If western nations refuse to explore and drill for oil, then demand may one day surpass supply and the price of gasoline may reach $10 per gallon, a price that may damage the U.S. economy and cause enormous suffering for the poor of the world.

As to government intervention, the United States government should do NOTHING to artificially interfere with people's energy consumption habits. The government should get out of the way and let consumers and the free market respond to oil prices. Government intervention is more likely to cause additional problems than provide solutions. A case in point is the government mandated use of Ethanol which most experts credit for contributing to the global rise in food prices.

Over the last five years, the American car industry has responded to high oil prices by taking numerous steps to improve the efficiency of their automobiles. For example, GM, Ford and Chrysler began mass producing vehicles with cylinder deactivation technology whereby a vehicle switches from eight cylinders to four cylinders when road condition allow for such reduction in power and energy consumption. GM is near completion of the Volt, a new car that promises to take energy consumption to new lows. All car companies are now producing hybrids. The point here is that the car companies did not take the above mentioned steps because the government asked them to change, they began changing their cars when their consumers and the free market demanded more efficient cars.

As to other forms of energy, such as solar, wind, hydrogen, etc., the market and consumers should decide the extent of their use. The consumer will naturally begin using other forms of renewable energy once it becomes cost effective to do so. The fact is, oil continues to be the most cost effective and efficient of the available sources of energy. This is a fact that should not be denied for political reasons.

Posted August 24, 2008 by Kamal Nawash

Comments

Good ole supply demand and glorious profit


I appreciate this article. While Arabs are not to blame for the rise in oil prices, the bigger tragedy is that many of our fellow Americans while continuing to believe this or some other theory, do not seek real solutions but instead complain to their elected officials for a fix - which you and I both know always makes the situation worse in the end. Lassis Faire - I say.






Regards,

Posted August 25, 2008 by Kenneth Larson

I happen to agree with this article and Kamal's perspective on the whole, but I think it's a little irresponsible to blame ethanol as being partially responsible for the rise in global food prices without also acknowledging the contribution of the rise in fuel prices.

Posted August 25, 2008 by MKKDASH1

Hey Nawash,

The fact that you started the article by saying that most politicians and writers have no clue what they are talking about, shows how clueless you are...! Why don't you educate us on your back ground in economics and the oil industry? The more you speak, the more foolish you make your self look. My suggestion is that you keep quiet.

Sincerely

Posted August 25, 2008 by John Doe

Man, I didn't know that FMC was still intact. I thought it was defunct!

Posted August 25, 2008 by Ty Wheatley

Posted August 25, 2008 by Prof. Trollstein

Re: Ethanol and Methanol As Alternative Liquid Fuels and Fuel Prices
Dear FMC and Readers:
Mr. Nawash is mistaken in citing "experts" on ethanol being the cause of higher food prices. Those making this claim are not "experts" by any definition. First, ethanol has brought down the cost of gasoline in the U.S. by not less than 25 cents per gallon. The increase in a cost of corn in a box of corn flakes due to corn ethanol is approximately 6/10 of a penny, that is $0.06. It is meaningless. THE PRIMARY CAUSE FOR THE INCREASE IN FOOD PRICE IS THE INCREASE IN THE PRICE OF OIL. Oil is used to make fertilizers, run farm equipment, the harvest, crop transportation, drying and other processing, packaging and transportation of the packacked food. The facts are self-evident and it defies logic to state otherwise.
As for wheat, the price has been primarily effected by a combination of a drought in Australia and a fungus over much of the world. The price of rice has been affected by a combination of drought and government controls restricting rice exports from major rice growing countries and subsequent speculation. Also, rice is grown on totally different land -- flooded plains -- than is corn. Also, corn for ethanol is not the same grade as that used for food. The U.S. is growing more corn than ever because we are exporting more plus it is being used in increasing quantities to feed meat animals. The amount of corn used directly for human food is only 5% of our crop. The claim that ethanol is raising food costs is irresponsible propaganda and nonsensical.
Further, if oil is only $50 per barrel, corn ethanol is a competitive fuel. Currently, oil is $120 per barrel so what sort of nonsense is it to blame a $50/bbl fuel for the havoc reeked by a $120-160/bbl fuel?!
Also, we need a flex fuel vehicles manufacturing mandate to be immediately passed by Congress. So much for Mr. Nawash's 100% market mechanism cure. The fact is that the market -- with a $250 billion a year subsidy to oil (if not $1 trillion) has gotten us into this mess to begin with. A little government mandate and tax incentives can help get us out. America needs ethanol and methanol as our primary liquid fuels. This will bring jobs, money to the treasury, reduce the trade and budget deficits and increase our economic, political and military security. It will also give Caribbean and Central American nations economic development opportunities when they replace radical Mideast regimes as our suppliers!

Posted August 26, 2008 by Jarrow L. Rogovin

It is much easier for politicians to demagogue this issue than to actually be truthful. Case in point, we often hear about "windfall profits" and how politicians want to tax them at a higher rate. The actual truth is that Oil Companies operate on a profit margin of 8.5%. And for every dollar in profits that an oil company makes, the government takes about $.62 so when they speak of windfall profits, they are neglecting to tell everyone that the government is making twice as much on a gallon of gas as the oil companies are. But the oil companies are evil and the government is good...excuse me while I barf.
Back again, did you get the Garlic and start taking it???

Peace

Posted August 26, 2008 by Tony

Posted August 26, 2008 by Adam E. Carr

Interesting Article, Mr. Nawash. Do you have a graph comparing the increase in relative price of petroleum to other major consumer commodities? i would be interested to see and venture that the relative comparison will surprise us. I may be wrong, but I think the increase in the price of other major consumer commodities (milk, bread, eggs, corn, bacon, beef, chicken, etc.) will be higher than the price of Oil. Why would expectations regarding oil be any different than other consumer commodities? Is there some cognitive dissonance going on? I will be interested to see how that thesis holds up. Just curious...

Sincerely,

Posted August 26, 2008 by A.P. Pishevar, Esq.

I think Mr. Nawash is saying use all forms of energy by don't exclude or reduce the production of oil which is the most efficient to date. I don't see anyting wrong with his arguments. Let the peple decide what they want.

Posted August 26, 2008 by buraq

Nawash,

A well written article. As the economists say, oil is "priced on the margins", which means that a small margin of scarcity or surplus dramatically increases or decreases world prices, respectively.

Ethanol is nothing but a subsidy to the U.S. farmers and does little, if any, to solve the energy problem. It does, however, dramatically increase corn prices along with the other grains that are substitutes for corn in the food chain.

Why is corn conversion to ethanol so inefficient? To convert corn to ethanol involves the extra step of converting the corn starch to sugar by the malting process. Then fermentation and distillation. There are losses and expenses with this extra step.

Brazilian sugar cane based ethanol is much more efficiently (and cheaply)converted to alcohol because it does not have to be malted. That is why the Congress, in their infinite wisdom, has slapped a $0.50 gallon tariff on Brazilian ethanol.
In other words, the U.S. ethanol program is nothing more than a subsidy to the U.S. farmers because they could never compete with the Brazilians. Driving up grain prices is an intended consequence of this subsidy.

Thanks for the article, Nawash.

Douglas210

Posted August 26, 2008 by Douglas210

A good sounding article, but no information worth anything. Sounded like a politician wrote it.

Points missing--without understanding these points, any information is worthless.
: the 60/40% for the price of oil.
The Kissinger Accords
Who are the oil speculators?
Bildeberger Cabal
Think Tanks that brief the cabal at their meetings.
Oil pipelines in Asia/middleeast area
Oil find in Montana, North Dakota etc area.

The article made me remember the Clinton era--He didn't tell the truth, but atleast he did not lie.

Posted August 27, 2008 by Paul

Surely the American car industry's progress in MPG was a reaction to the public's need for better fuel efficiency which was triggered by government controls on drilling (which has led to higher prices as you say) as well as to compete with the better MPG of foreign car manufacturers. I suppose this would translate to the government's control on drilling has actually led to more fuel efficient vehicles which leaves the consumer with a better product, which in my opinion isn't a bad thing.

Posted August 28, 2008 by whufc84

Sidrago and whufc84

I don't know what Mr. Nawash said that was wrong. Everything he said makes sense. Sidragon what you are basically saying is that this is question of supply and demand which is what Mr. Nawash is Saying.

As to whuf, you sound like a member of the Green Party

Posted August 28, 2008 by Michelle

Here are the fundamental problems. First, the United States is not the only nation or entity interfering with the free market. What is OPEC but a cartel. There is a reason anti-trust laws exist. To stop the "haves" from preventing the "have-nots" from entering the market and competing. Likewise every freemarketeer (and I am one too, in the true sense) forgets that everytime a nation sends their military into a region to protect their economic interests it means they are protecting an industry and therefore usually only a few large firms. This is equivalent to a bailout and should not be tolerated. If your company gets involved in a volatile area of the world and that volatility hurts your business then too bad for you. Make better decisions next time.

Oil supply is finite and while I agree that the price is being driven by demand the price is not sue to America protecting their shorelines. If you always insist on short-term accounting then preventing offshore drilling seems wrong but if you are willing to consider longer term economics it might make sense to prevent more drilling to protect other resources we may need in the future.

Btw, whoever made the asinine comment that someone "sounds like a member of the green party" ... What's your point? Is that an arguement? I'm sovsuck of these stupid ad-homonym attacks. Like calling someone a liberal or a republican. Make your arguement. Don't rely on anti-intellectual attacks to do your dirty work for you.

This is an example of the terrible decline in our ability to debate.

Posted August 29, 2008 by lewgold

excellent article. Government should get out of the way of innovation and the market forces.. The one thing the public needs to be aware of is that even if the price wouldn't come down by drilling and building refineries, which they will, the most important aspect is increasing a STABLE supply. Nowhere in the world is there a more stable source than in the US. You see what is happening in Nigeria, the Middle East and Russia and we should be worried about the supply being cut off from one or more of these regions. Then we would have NO gas, forget about low price for gas.. We need to step it up before the time comes when we are caught between a rock and a hard place. If we started 10 years ago, we would be there already. Those who complain about how long it will take are not looking out for our future. Most of the time they are wrong about how long it would take because of the new technology developed today. They should allow oil companies to expand exploration, not hold them back. The enemy is not the US owned oil companies, it is the government run oil agencies supported by terrorist funding regimes.. I hope, with your help, the American people will see how important it is to allow the free market to truly be a free market and stop government interference in the system.. Oversight is good, but they shouldn't dictate how and when certain companies need to operate.

Posted September 14, 2008 by Anonymous

These political issues are such a tough stuff! You never know who is right is who is wrong. As for the situation with the oil, I'm afraid there will never be solution found (. News videos at http://www.picktorrent.com with the experts' opinions prove my words.

Posted August 13, 2009 by meggy

Posted January 22, 2010 by Amer Al-bayya

The problem of oil supply has been exasperated by western nations, including the United States, who refuse to allow drilling for additional oil. The refusal to allow additional drilling is interfering with the free market system from efficiently responding to high oil prices. It is absolutely irresponsible for the United States government to prevent the oil industry from producing oil anywhere and everywhere that oil maybe found and produced in an environmentally sound way.

Posted January 17, 2011 by asid