The real reason behind oil price rises
In an interview, energy economist James Hamilton reveals how demand for oil keeps outstripping production, even with new shale oil supply coming from the United States.
Nowadays the energy picture is confusing at best as the more information we are shown the more blurred our vision seems to become. Mixed messages, poor reporting and a media hungry to sensationalize anything it thinks can grab a headline have led to many wondering what the true energy situation is. We hear numerous reports on how the shale revolution will transform the energy sector, why alternatives are just around the corner, why advances in oilfield extraction techniques and new finds will help to lower oil prices. Yet no sooner have we read these rosy reports than we are bombarded with negative news on the Middle East, on why alternatives will never compete, on peak oil and declining oil production.Skip to next paragraph
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So where do we really stand? Is our energy future one of falling prices and plentiful supply or should we prepare for declining supply and sky high prices?
To give readers a real understanding of where we are Oilprice.com was fortunate enough to speak with the world’s leading energy economist, Professor James Hamilton. James is a professor in the Economics Department at the University of California, San Diego. He has been a visiting scholar at the Federal Reserve Board in Washington, DC as well as many of the Federal Reserve Banks; and has also been a consultant for the National Academy of Sciences, Commodity Futures Trading Commission and the European Central Bank and has testified before the United States Congress. You can find more of his work on his website Econbrowser.
In the interview, James discusses:
• Why we shouldn’t get too excited with the shale revolution
• The “Real” cause of high oil prices
• The incredible opportunity presented by natural gas
• Why long term oil prices will creep upwards
• The geopolitical hotspots that could cause an oil price spike
• Why sanctions could cause Iran to lash out
• Why speculators and oil companies are not to blame for high oil prices.
• Changes we can expect to see under a Romney Administration
• Why Short term oil price forecasts are worthless
• Peak oil & Daniel Yergin
Interview conducted by James Stafford of Oilprice.com
James Stafford: Oil prices have shot up in the last month. What range do you see oil prices trading in over the next 12 months?
James Hamilton: Oil prices have always been very volatile. If you look at 12-month logarithmic changes in WTI going back to 1947, you come up with a standard deviation of 0.27. In other words, 25% moves up or down within a year are fairly common, and 50% moves or greater have also been seen on a number of occasions.
If you look at options prices at the moment, they imply the same level of uncertainty looking forward. For example, somebody today is willing to pay $2.90/barrel for a NYMEX option to buy oil in September 2013 at $120/barrel, consistent with a standard deviation of annual log changes of 0.26. The market is saying that prices that high or higher are not that remote a possibility.
And if you look at current fundamentals, it’s not hard to imagine big moves in either direction coming fairly quickly. The price of oil would surely collapse if we saw a significant economic downturn in China (something nobody can rule out) or if Iraq succeeds in producing even half of its ambitious production targets (though I personally consider the latter unlikely). On the other hand, a military confrontation with Iran could produce a pretty spectacular price spike. If the Strait of Hormuz were to close, for example, it would represent a shock to world production that in percentage terms would be 3 times as big as the 1973-74 OPEC embargo.
Because the demand for oil is so insensitive to the price over the short run, and because there is little excess capacity in the world at the moment, even small disruptions or additions could produce big price changes. For this reason, I do not have a lot of confidence in anybody’s near-term oil-price forecasts.
On the other hand, I think we understand pretty clearly the main factors behind the overall increase in oil prices since 2005. Demand for oil, particularly from the emerging economies, has grown significantly, and we have had a hard time increasing global production. The single most likely outcome is that both conditions will continue to be with us. The most likely scenario is that the next decade will look something like the last, with oil prices volatile but exhibiting an upward trend. (See Why are oil prices 10 times more than in 1998?)
James Stafford: For the past century or so, economies have generally been built upon energy. The economies with access to plentiful, cheap energy have developed the most. With the stagnation of oil production growth, how do you suggest economies could continue to grow from here? Should we stop expecting to see constant economic growth as the norm?
James Hamilton: I think this has put a significant burden on the oil-consuming countries. These economic problems have been compounded by the fact that some of the key manufacturing that once came out of countries like the United States and Japan has now been taken over by the emerging Asian economies.
But there is still a strategy for trying to take advantage of the resources we do have. The United States has had astonishing success in producing natural gas. This could be the basis for a renewed manufacturing advantage, a new source of U.S. exports, or an alternative transportation fuel. We should be looking for regulatory reform and infrastructure investment to encourage consumers and entrepreneurs to adopt alternatives to conventional gasoline-powered vehicles.