Wednesday, July 02, 2008

Your Must-Read Oil Story Of The Day

As part of my ongoing efforts to understand why I'm paying four-freakin'-dollars(!) for a gallon of gasoline, I've been reading less and less of the Boston Globe-Democrat, and more analysis by actual economists.

One of them, Harvard's Martin Feldstein, has today's must-read insights into why "evil speculators" are not part of a secret cabal to force oil prices up on behalf of Halliburton...or whatever the conspiracy theory of the day happens to be.

Instead, Feldstein makes some common-sense economic observations about the real world:

Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.

There are of course considerations of risk, and of the impact of price changes on long-term consumer behavior, that complicate the oil owner's decision – and therefore the behavior of prices. The Organization of Petroleum Exporting Countries (the OPEC cartel), with its strong pricing power, still plays a role. But the fundamental insight is that owners of oil will adjust their production and inventories until the price of oil is expected to rise at the rate of interest, appropriately adjusted for risk. If the price of oil is expected to rise faster, they'll keep the oil in the ground. In contrast, if the price of oil is not expected to rise as fast as the rate of interest, the owners will extract more and invest the proceeds.

The relationship between future and current oil prices implies that an expected change in the future price of oil will have an immediate impact on the current price of oil. [emphasis added]

In other words, if oil producers expect their oil to be worth less in the future--because of, oh, like more drilling and stuff?--they will get it onto the market today and prices will drop.

Unfortunately, American liberals like Sen. Obama, Gov. Patrick and Sen. Harry Reid don't WANT lower prices. They want lower demand, and that comes with higher prices.

So if you support $5 a gallon (or higher!) heating oil for granny this winter and next, you can have it. Just vote Democrat.