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July 6th, 2008| 
This is the first part of a multi-post series that discusses our current energy crisis. The first thing we need to ask ourselves is why oil is so expensive. After that, we’ll look at some common myths about solving the oil criss, and look at some real solutions.
Before we get started, we need to establish a few general ideas, however.
1. The current oil crisis is not caused by one entity, issue, or root cause.
2. There is no ’silver bullet’ for dealing with our current crisis.
3. Oil is not a long-term energy solution. Even if you think the Peak Oil folks are a bunch of crazy whackos, the fact remains that there is a finite supply of oil, and at some point we will run out of it. Much sooner than that, we’ll run out of oil that is economical viable to extract and use. Even sooner than that, production of oil will be unable to meet global demand.
4. The market for oil is global. When we say “we” produce more oil, what we actual mean is that companies inside the United States produce oil for sale on the global market.
Keeping those 4 rules in mind helps us get a better idea of what the problems we face are and what sensible solutions we have for dealing with them.
With that in mind, let’s think a little about why oil is so expensive. Indeed, we’ve seen oil go from in the mid $20’s per barrel in 2001/2002 to over $140 per barrel in July of 2008. Gasoline, under $1 per gallon as recent as 1999, is over $4.00 per gallon in most states. The price of gas is rising almost daily and is a major topic on the news, around the water cooler, and even around the kitchen table.
Who is to blame for this? Greedy oil companies and gas stations? Hippies that won’t let us drill anywhere? Scheming OPEC countries? Mysterious oil traders?
Finding one entity to blame, one root cause of this problem is very tempting. It gives us someone to protest against and it gives rise to all the “easy” fixes for the energy crisis we see floating around the internet. Unfortunately, no one entity or problem is to blame. Here are a few of the root causes:
1. Supply vs Demand
Demand has increased significantly since the early 2000’s, but supply has not kept up. I charted supply vs demand data from the EIA’s petroleum statistics website, and this is what it looks like:
You’ll notice that around 2006, the lines cross - demand exceeds supply. When demand exceeds supply for such an important commodity, this can create a lot of upward pressure on prices.
Everyone is quick to point at OPEC, but there are two problems with that. The first thing to remember is, it isn’t in OPECs best interest for oil prices to be so high. They’d prefer them to be around $50 per barrel - enough to make tons of money, but not so much that people begin to have huge incentives to look for alternate sources of energy.
Demand for oil has continued to increase due to nations such as China becoming more and more industrialized, and thus using more oil. We have to realize that as the rest of the world catches up to North America and Western Europe in terms of industrialization, they will use significantly more oil.
Can OPEC and other oil producing nations increase production? Probably (and Saudi Arabia has agreed to by ~2 million barrels per day), but there doesn’t appear to be much more room on the supply side.
2. Geopolitical Uncertainty
Let’s go back to the EIA’s website and have a look at the top oil producing nations -
We can easily see that some of the biggest oil producing countries are also unstable countries or within unstable regions: Saudi Arabia, Iran, Venezeula, Kuwait, Nigeria, Algeria, and Iraq. In most markets, including oil, instability adds a premium to the price of the commodity. Our actions in Iraq, our belligerence toward Iran and Venezuela, and Israel’s threats toward Iran have all added to the cost of oil.
In addition, this is one of the biggest problems with our reliance on oil - it ties us to unstable regions, and causes us to undertake actions that may have negative consequences in the future. Cutting our reliance on oil will help us avoid some of these troubled areas.
3. Speculation
There are a lot of people who think that the supply vs demand imbalance will continue to grow in the future - and a lot of them are willing to bet money on it. Geopolitical events such as we described in the previous section cause this speculation to grow, meaning that the price of oil can increase without any actual change in the cost of producing oil or in the supply vs demand equation. Few, if any, commodities markets are as affected by geopolitical events as the oil commodity market.
4. Weak Dollar
Again, using data from the Energy Information Administration, 1 barrel of crude would cost you $19.81 in January of 2002. Oil was trading for $144 on July 3, 2008. This is an increase of over 700%! If you were to price that in Euros, however, in 2002 it would cost you €21.83 and on July 3, 2008, €91.26 - an increase of only 400%. In other currencies, the increase is signifcant, but not as much as the USD.
A weak dollar is good for some people and bad for others, but when it comes to oil, a weak dollar is a bad thing. Poor fiscal policy, an expensive war, turmoil in the financial sector, low interest rates, and a generally soft US economy all combine to push our dollar down. Even worse, as we spend more and more on oil, this pushes the value of the dollar down, forcing us to spend more on oil, and on and on..
That is it for now. Feel free to send in your questions, comments, hate mail, etc… Next up, we’ll take a look at some common myths and misconceptions about the oil market.
