Wednesday, September 17, 2008

Someone asked me yesterday...

...why the price of oil is down. They thought that since the market was in turmoil, the price of oil should be through the roof. And since the price of oil is down, why hasn't the price of gas gone down, too?

I said it's not quite that simple.

The first issue is supply and demand, of course.

There are two sub-issues regarding supply - one is the cost of the oil itself and how much is available on the market. Production has peaked for most fields and is in decline, this means less crude on the market and pushes prices higher. The other is refining capacity - if you found a whopping gigantic oil field under your house tomorrow with a hundred years of oil in it, it still has to be refined to get to the market. Right now, most refineries are 30+ years old and are at production capacity. Few new ones are scheduled to come online, so even if you have a mile high pile of oil, it will only go through "the system" at a certain rate. At the moment, our production is adequate for our demand - but just adequate. There is not much reserve and not much slack in the system, so production costs are more or less level - not going down.

On the domestic demand side, of course, is primarily personal automobiles. If you removed those from the equation there would be plenty of oil for plastics and fertilizer and what-not - private automobiles eat the lion's share of petroleum resources. And evidence is that automobile usage has gone down. More people are biking, walking, and riding mass transit than ever. This is good - it causes the price of oil to go down due to increased supply.

In the international demand side, places like Beijing greatly curtailed automobile usage for over a month for the olympics, and there is evidence of a recession in China which has further depressed demand. Since China is now our biggest "competitor" for oil usage, their decrease in usage has allowed the price of oil to fall, also.

So the short answer is that demand, both domestically and internationally, is temporarily down.

However, with winter coming on, that will change, at least domestically. First, people who are willing to walk or bike in nice weather won't be so willing during the winter. So automobile use will go up as the weather gets bad. Secondly, of course, is the heating oil requirements of homes and offices. A large percentage of the northeast and some other areas of the country uses heating oil as their primary source of climate control for their homes and offices and businesses during the winter months.

Another issue involving oil prices is "speculation," that is, the futures market. The futures market has physical supply and demand as only part of the equation for figuring out what the future of oil usage will be - the broader picture includes employment because people who are employed use their car more than people who don't. Unemployment, both the "official" unemployment and the real unemployment that includes people who have been forced off of their unemployment benefits continues to grow by leaps and bounds. The hundreds of thousands of people who are starting to lose their jobs in the financial industry, for example, really have no where else to work. There aren't enough wally-wort and pizza-mia and lawns-r-us jobs out there (you know, that great "service economy" where we all make a living doing each other's chores) to absorb all of these people, much less real jobs, which are fast disappearing in a real "trickle-down" effect of unemployment as the little firms that serviced the big firms start going under. The real rate of unemployment has a profound impact on anticipated car/oil usage - and it's only getting worse. It's just another aspect of falling demand. And since supply is adequate but demand is falling like a rock, the price of oil is down for the time being. Investors are looking at the overall economy and see that, frankly, it sucks. Poor people can't afford to take vacations or drive a lot. So there's no "future," pun intended, in oil investments for the short term.

And, of course, even though oil itself is not that expensive (relatively speaking) right now, the price of gasoline and diesel is holding steady at a historically higher rate, due to processing and transportation costs being up. So even though the price of oil is down, the price of gas/diesel is not greatly down, and many, many people are still basically being priced out of the market more or less permanently. The rising tide of unemployment will add to this number, of course.

I hope that was somewhat helpful.

No comments: