Why oil is so expensive
Don't blame OPEC. The major factors are a weak dollar and speculation.
By Paul Robertsfrom the December 18, 2007 edition
Page 1 of 2
For years, the Organization of the Petroleum Exporting Countries (OPEC) has argued that oil prices are being driven by external factors such as the weakening dollar and speculators – and are thus out of the cartel's control. And for years, skeptics have dismissed such claims as cover for the cartel's greedy unwillingness to pump more oil.
Recently, however, even the skeptics are acknowledging the price-pushing power of non-OPEC forces in the oil market – forces that could be doing importers as much damage as anything the cartel ever tried.
The most obvious is the sagging dollar. Because oil is priced in dollars, and because the dollar's value has fallen nearly a third against major developed-country currencies since 2002, Americans are spending more – perhaps as much as $20 more – for a barrel of oil.
And that pales against what speculators might be adding to the price.
Although all commodities can be manipulated by speculation, oil is especially vulnerable. First, oil is prone to supply disruptions, whether from hurricanes or border wars. Second, the global oil system is highly opaque. It has so many pieces – producers, refiners, shippers and distributors – that no one knows precisely how much oil is in any given place at any given time. This means that estimates of how much excess inventory is in the system – and thus, how big a buffer we have against a disruption – can change rapidly.
So when the United States Department of Energy, for example, announces a "surprising" decline in US oil inventories – and by implication a smaller buffer – the oil market responds by driving up prices.
Oil is, in other words, an inherently volatile commodity and thus highly attractive to traders, who profit by betting on the daily and even hourly fluctuations in price. And while there's nothing criminal about betting on price, it is a problem when the bets themselves influence the price. If enough traders gamble that oil prices will rise over, say, the next 30 days, then the price of 30-day oil futures contracts will rise, which eventually will pull up the current, or spot, price of oil – the classic self-fulfilling prophecy.
And because traders are always looking for anything that might warrant a price increase (and thus, the placing of a bet), the smallest events – unrest in Nigeria, for example, or even upbeat economic news (which implies greater oil demand), become potential catalysts for a price rise.
Just how large this "speculative premium" is has become a matter of intense debate. Historically, says Fadel Gheit, a veteran oil analyst at Oppenheimer & Co. in New York, oil prices have run about three times what it costs to physically extract a barrel from the ground. Given that these extraction costs run between $15 to $19 a barrel worldwide, the "correct" price should be somewhere between $45 to $57. Indeed, as recently as 2005, OPEC itself claimed that $45 was a reasonable price.
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