Global warming guilt and record oil prices

03 May 2008

The reasons commonly espoused don't fully explain the more than 10 fold jump in crude oil prices over the last decade. Maybe, oil is pricey because we all have started feeling guilty about consuming it! By Shivshankar Verma

Most commodities follow the simple principles of demand and supply – higher demand leads to higher supply, attracts more producers, which in turn leads to higher supplies and lower prices. Stung by unremunerative prices, suppliers cut back production, prices recover and market reaches equilibrium. Then the cycle starts all over again. This is simple enough to understand and we are all increasingly willing to take this 'free market' behaviour for granted.

However, real life is more complicated than fiction and even textbook economics.

The price history of crude oil has been no different. This most prized of all commodities has gone through many price cycles over the last century, since hydrocarbons emerged as the major energy source. The last major spike in oil prices was in the '70s when Arab countries imposed a production embargo following Israeli attacks on Syria and Egypt. Prices surged even higher in response to the Iranian Revolution and the Iran-Iraq war. Oil cartel OPEC was established even before the '70s oil crisis and paved the way for a definite shift in market influence in favour of the producers.

At the peak of the oil crisis in '70s, there were any number of oil analysts who predicted that the world would soon see a peak in oil output and prices would continue to rise further. Demand was high in major markets while production in the older oilfields in western countries was declining. OPEC members were emerging as the major suppliers, giving the cartel significant pricing power. Geopolitical uncertainties abound in major oil producing regions, creating supply uncertainties. It appeared quite possible that high oil prices were there to stay.

Yet, prices started declining even as as the supply uncertainties dissipated. Though demand continued to rise, the market was awash in oil and prices plummeted. The 'peak oil theory' was promptly discarded. Except for a short rally during the First Gulf War, oil prices remained weak throughout the '80s and '90s. The bottom came at $10 per barrel in the late '90s.

The market bottom triggered another wave of predictions, this time about cheap oil. It was widely accepted that the world was awash in oil and would remain so in the foreseeable future. Technological advancements were expected to reduce demand through the development of alternate energy sources while at the same time supplies were expected to improve with better production technology. Even the respected The Economist magazine predicted oil prices to slip to $5 per barrel! That never happened and prices have been on an upswing ever since.