The price of oil has been rather symbolic of our boom/ bust economy, although oil is even more volatile. There are a lot of factors going in to the price of oil.
There is the global supply of oil, which is affected by war, politics, cartels, government regulations, and investment in production, among other things.
There is the demand for oil, which we forget is not just in the United States, but also worldwide. With big developing countries, particularly China, demanding more energy, it has a huge impact on oil demand and investment for future oil production.
Another factor that is often overlooked is central bank policy. Since oil is bought and sold with dollars or some other currency, the supply and demand for money also affects the oil price.
Even interest rates have a significant impact. If we did not have such low interest rates over the last several years, would there have been so much investment in North Dakota and other places for oil production?
Just over the last 15 years, the price of oil has been wildly volatile. In the late 1990s, the price of crude oil was under $20 per barrel. It then started rising at the turn of the century. The price dropped again after September 11, 2001, but then quickly started rising again.
After the Iraq War was in full swing, the price went higher and higher, eventually going over $140 per barrel. Then the price crashed once again with the major economic downturn of 2008, going all the way back below $50.
When the Fed started pumping in massive amounts of money, the price of crude quickly went back up to over $100. Just last year, the price fell back below $50 and is now close to $60.
This volatility is probably not going to go away because of the many factors mentioned above. Between OPEC production, foreign entanglements, central bank policy, and economic conditions, the price of oil can change quickly and in either direction.
Last year, the price tumbled, and it tumbled further when OPEC announced it would not be cutting production. Many people speculated that the Saudis were doing this on purpose. Some speculated that the Saudis were taking orders from the U.S. government in order to hurt Russia, which relies on oil sales for a good portion of its economy and tax collections.
Others speculated that the Saudis were also trying to bankrupt U.S. oil wells that had sprung up in North Dakota and elsewhere. It is possible the Saudis wanted a low oil price just long enough to drive away some competition.
Are the Saudis Bluffing?
T. Boone Pickens, the wealthy oilman, was recently on CNBC discussing this situation. He basically said that Saudi Arabia is near maximum production right now, at just over 10 million barrels per day. He does not believe they can go to 12 or 13 million per day.
Pickens also pointed out that much of the U.S. investment in oil production, in such things as shale oil, has gone into unconventional wells. He says that these wells decline in production rather quickly as soon as they are up and running, unlike conventional oil wells.
For these reasons, Pickens believes that oil prices are going up. More specifically, he sees oil prices returning to at least $70 per barrel by the end of the year.
With Pickens, I have no idea what his own agenda is in this game. But the man obviously knows a lot about the oil business. If he thinks the Saudis are bluffing and can’t increase output from where they are, we should take this warning seriously.
In economics, there is a saying that the cure for high prices is high prices. The same theory applies the other way. The cure for low prices is low prices – not that consumers would want to “cure” low prices.
But when prices are low, investment drops off quickly. This will bring down future supplies from where they would have been if prices had stayed high.
There are many factors that could possibly drive oil prices higher. They include more war, more demand from developing countries, production cuts from OPEC, and central bank inflation. We should especially keep that last one in mind.
Probably the biggest threat to potentially rising oil prices is a recession. If the economy significantly weakens – particularly in the U.S. but also in China – then this could certainly soften demand and bring prices down in the short run.
In the longer run, Pickens is probably going to be right about this. It is too hard to say that oil will be $70 by the end of the year, just because of the short timeframe. But higher oil prices seem to be a fairly safe bet over the longer term.
Oil prices will eventually come down when new forms of energy are developed that are cost effective. While technology is advancing rapidly, it is hard to imagine any new energy replacing oil in the next decade. For this reason, consider me with Pickens on this one as an oil bull.
