What You Should Think About Oil Prices

November 18, 2007

“Time destroys the speculation of men, but it confirms nature.”


When expressing hostility toward the Carter administration, critics often fault the former President for poor economic conditions, with particular emphasis on high oil prices, that he left behind after losing the 1980 election. Since most of this hostility comes from devout political partisans, it is hard to imagine how they will rationalize a strikingly parallel scenario unfolding as the second Bush administration comes to an end.

At least in Jimmy Carter’s case, the machinations of OPEC and a largely unjustified surge of anti-American sentiment in the Middle East could be blamed. Today, supply throttling by OPEC is virtually a non-issue, and there is the matter of tens of thousands of dead Iraqi civilians (among other things) to justify strong anti-American sentiment throughout much of the Middle East. Even so, this phenomenon clearly has its roots in something much bigger than inept American leadership transforming a long-standing culture clash into a seething pit of perpetual warfare.

Clearly there are many factors driving the price of oil to new heights. Perhaps foremost among them are concerns about the prospect of a war between the U.S. and Iran. It is no secret that the same folks who brought us the current Iraq policy are drooling at the prospect of violence against Iran. The problem is that, while the world community united in the 1990s to ban Iraqi development of weapons of mass destruction, Iran is a sovereign nation that has not violated the territory of any other nation since the Iran-Iraq war of the 1980s (itself a direct result of Saddam Hussein’s attempted invasion of Iran.)

The United Nations Security Council may be able to agree that Iranian nuclear weapons are a bad idea in principle, but in practice taking action against such a program involves setting a dangerous new precedent in which military aggression by powerful nations is permitted for no reason other than the crudest possible approach to preventing nuclear proliferation. The idea that the government of Iran would provide nuclear weapons to terrorist organizations is (as with much of the public rationale for war in Iraq) bogus on its face. Yet that misinformation is, in some circles, a more popular idea than the notion that military aggression to destroy foreign nuclear facilities would push future nuclear research so deeply into realms of secrecy that it would become much more vulnerable to abuse by madmen.

Yet the price of oil is as much influenced by Iranian leverage as American belligerence. Iran controls a great deal of coastline along the Persian Gulf. A hostile Iran has a range of options including rocket attacks on outbound oil tankers and rendering the Strait of Hormuz extremely perilous to navigate. Among other things, such an action would put a serious restriction on Iraq’s already troubled capacity to get oil to consumers abroad. Whether the U.S. backs off on pressures to let American corporations control Iraq’s most valuable natural resource or those pressures somehow wind up producing results, none of it will matter if the oil cannot be floated safely to markets abroad.

What all this means is that every time the President and his associates say something profoundly ignorant about World War III, they also say something that is certain to intensify the speculation driving up oil prices at present. This is certainly a key consideration — the current price of oil is as much a reflection of investors’ willingness to bet on even more extreme instability in the Middle East as it has anything to do with supply and demand. The more opportunists see a chance to make a fast buck by speculating on further increases in the price of oil, the more that price will continue to climb without regard for underlying realities.

Of course, the underlying realities are no cause to dance a jig. Decades of vigorous consumption have put an end to most of the “low hanging fruit” in petroleum economics. The world’s reserves are still enormous, but they are increasingly remote and increasingly difficult to process into useful fuel. These complications of supply are paired with increasing demand. The United States under President Bush has made a habit of forfeiting opportunities to engage with China and other rapidly growing economies in pursuit of global accords that might conserve resources or hasten the rise of alternative energy enterprises.

This means that there are real fundamentals driving oil prices higher. This also happens in the context of real fundamentals driving the value of the dollar lower. Years of poor economic stewardship and even poorer foreign policy have changed financial realities within the United states while radically transforming public perceptions abroad. Once unquestioned in its reliability, the greenback is no longer the Old Faithful of international currencies. Toothless government oversight of American capital markets (with mortgage debt resale being the tip of the proverbial iceberg) shakes confidence on one level while years of nonsensical proclamations and actions from the White House rattle a different set of analysts.

A view I find myself on the fence about is that the war in Iraq was really all about the petrodollar. Equal parts sensible analysis and kooky conspiracy theory, it holds that the real reason for all that violence was that Saddam Hussein was on the brink of orchestrating a Middle Eastern oil market that pegged prices to euros rather than dollars. There is much more evidence the Iraqi regime had such a plan in the works than there ever was evidence that they were developing weapons of mass destruction. On the other hand, wouldn’t launching a profoundly ill-advised war do at least as much damage to the world’s faith in American stability as any new commodities exchange ever could?

Fortunately, there are many factors that could bring the price of oil down, or at least seriously restrain its ascent. If saner heads prevail before a U.S. attack on Iran occurs, speculation based on the likelihood of that conflict will have been in error. Astute observers of world events are also suggesting that China may go green of its own volition — the waking dragon may simply skip a filthy phase of industrial development and strive for a leadership position in the realm of economic sustainability. Then there is also the prospect that, one way or another, chaos in Iraq will subside and Iraqi oil fields will produce a noteworthy surge in supply.

As with so many other geopolitical issues, the price of oil is clearly influenced by a range of complex factors. Yet for years now, conventional wisdom among speculative investors has held that “the smart money” is on increases. It is fair to question if the latest wave of increases would have happened at all if not for the scandalous losses and shameless deceptions major American financial institutions have sustained from abuse of an underregulated capital markets. If the Bush administration is able to go forward with aspirations of unilateral military aggression against Iran, then I believe the sky is the limit on the price of oil.

Yet in the absence of such a disaster, it seems increasingly likely that this conventional wisdom is a suckers’ bet. In spite of all the valid pressures pushing the price of oil upward, rampant speculation means that this price is overdue for a serious correction. Even if the coming winter is harsh in New England or OPEC should decide to play their strong hand with deliberate slowness, tremendous pessimism is already factored into the current price. The world would have to become screwed up in some additional, severe, and unexpected way for those soaring numbers to continue such a steep climb.