Current oil prices: scarcity rents, political unrest, inflation hedging, or speculation

Michael Giberson

An article by Sarah Kent in the WSJ, “Gulf in oil prices may set up market for a fall,” takes notice of wide gap that has emerged between the current price of oil on the world market and the futures price of oil a few years into the future.

A variety of explanations for recent prices have been tossed around, from peak-oil related tightness in the market (aka “scarcity rents” in the jargon of economics), political unrest in some key oil exporting nations, use of commodity markets as an inflation hedge, or simple manipulations of evil speculators.

Here is the WSJ chart illustrating the matter:

The evil speculator story is mostly a useful story for politicians and regulators to grab more power over financial markets that lacks substantial evidence in support. The inflation hedge view would require future prices to be higher, not lower, than current prices. So is it peak oil or political unrest (or maybe some other view)?

The article notes that some analysts attribute the gap to an increasing expectation that oil production capabilities will rise, so future prices have eased, contrary to the beliefs of at least some peak oil advocates (for an example, see this post at the Scientific American blog). I’m sympathetic to the resource optimist view, but I think political unrest is the more obvious explanation.

The timing of the price moves in the WSJ chart are quite supportive of the exporter political unrest story. Both the May 2012 and December 2018 prices begin a sustained rise at the end of 2010, when the Tunisian Revolution erupted and began to spread. After about three months, though, the December 2018 price eased while the May 2012 price continued upward – this is approximately when the Libyan civil war became hot. The pattern would reflect an expectation that Libyan oil exports would not recover fully by mid-2012, but the market anticipated production would recover by 2018.

Note the most recent divergence between the May 2012 and December 2018 prices, emerging during the escalating political conflict surrounding Iran. The near term price is up $15/barrel while the more distant price has been unmoved by the conflict. Market concern about a potential interruption in supply, but not one that will endure, seem an entirely sufficient explanation.

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One thought on “Current oil prices: scarcity rents, political unrest, inflation hedging, or speculation

  1. I agree with you that political unrest may be causing uncertainty in supply and higher oil prices. However, is political unrest larger today than in the past? Arguably the biggest oil shock due to political unrest in the last 30 years occurred during the 1990’s when 1/2 of the supply of the former Soviet Union fell off after its demise. But we didn’t see that shock in oil prices then because there was more supply relative to demand at that time and the world oil markets adjusted easily to this shock.

    There is new oil coming on line from Brazil, Canada, US, Qatar, Angola, Azerbaijan and others but there is also been a big drop off from the North Sea, Indonesia, Mexico, Syria, Yemen, and Egypt, (the last three were falling rapidly from 2005 to 2010 before the Arab spring). Also, each year, demand for oil increases by about 1.5 mb/day due to China, India, and other developing countries. So supply is tight right now. This increase in demand will suck away almost everything extra Canada, US, and Brazil have to offer unless supply ramps up even faster than we have seen in the last five years.

    I have an alternate theory of why the future price of oil is lower than the spot price. It may not reflect merely a belief that supply will increase relative to demand in the future. It might reflect that the long run demand curve for oil is more elastic than in the short term and we are not on the long term demand curve for oil. High oil prices will cause a big long term erosion in the natural demand for oil by causing consumers to purchase more fuel efficient automobiles, trucking companies to shift to LNG, buses to shift to CNG, etc. If the price of oil remains at 8 times the price of natural gas for years, people will shift out of oil and into natural gas or electricity.

    Ironically, the lower price of oil in the future might be a sign that peak oil is finally happening. Because peak oil won’t occur when we run out of oil; it will occur when consumers run out of patience with high oil prices. That might be right now.

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