Saturday, February 18, 2012

Oil: The Culture Of Ignorance

The oil price screw is turning higher & higher. Last week WTI, the American type oil, rose to $103, Brent, the European variant, which the U.S. refineries use to produce gasoline, climbed to $119. High oil prices are a phenomena of the moment - instead of the sluggish economy thats been around since the year 2000. While stock prices stagnated in the late 90s, the price of oil quadrupled (wikipedia).

The price of oil doesn`t reflect fundamental factors any more. The market ignores supply and demand, and instead focuses on theories and speculations which are used as  excuses for high and rising oil prices.

There are two leading excuses for making the commodity more expensive: The peak oil theory and speculation about decreased oil supply from the Near East region (Saudi Arabia, Iran, Iraq which is still the leading producer:

1. The peak-oil theory claims that the global production of oil has already reached its peak and that world wide oil production is shrinking. It further claims that we will soon run out of oil.

Some authors call this theory "peak idiocy" (, because it ignores the profit motive, technological progress and the history of mankind, which has been finding methods to deal with rare resources for thousands of years. In recent years a lot of new oil sources have been discovered and explored, especially in Brazil, but also in countries like Ghana or Argentina. Russian crude oil production rose to Post-Soviet High in 2011 (bloomberg) and Canadian oil production is climbing again ( But the most encouraging development happens in the U.S., where oil production is rising significantly thanks to a better use of offshore resources in the Gulf of Mexico and due to advances in fraking, a method to extract oil from shale (bloomberg).

Increasing oil exploration is the natural response to climbing oil prices. The higher the price the more profits to be made by producing oil. Therefore the turning of the oil price screw attracts a lot of fresh capital into the production of oil. Rising oil production also is the result of new technologies which allow drilling deeper in the ground, exploring hidden resources under the surface of the oceans and extracting oil from the giant oil reserves in the shale (

2. Rising oil supply is constantly ignored because the market focuses now on geopolitical speculation. Many speculate that the oil supply from the Near East will be hampered by political factors. The trouble with Iran - the third-largest exporter of crude - is for years the center of this speculation. Since Teheran started it`s program of enriching Uranium, it is accused of building a nuclear weapon. Sanctions against Iran and the fear of a war in the Near East, which could hamper the deliveries from this region are driving the price of oil upwards. The oil price now has a huge Iranian premium ( The latest oil price hike is a reaction to the saber-rattling by Teheran, which threatens to close the Strait of Hormuz and to disconnect an import arterial for the flow of oil.

All these theories and speculation are fueled by a group which has a huge interest in high & rising oil prices: The oil speculators, mainly big hedge funds, who are betting $ billions on rising oil prices, and banks like Goldman Sachs, who earn $ billions by trading commodities.  Goldman Sachs especially is constantly beating the oil drum. The bank was partly responsible that the oil price climbed in 2008 to $147 - even when the recession already has started -, because they predicted then a price of $200 and were followed by many speculators.  Oil speculation gets  a lot of support from the mainstream media like Bloomberg which eagerly transmits any rumor and dismisses news about rising oil production.

How long can this go on? The experience from 2008 shows that a sharp rise of the oil price leads into a severe recession which also reduces drastically the demand for oil. In 2008 the price of oil imploded from $147 to around $40. We have already observed a shrinking demand for gasoline in the U.S., the largest user of oil in the world, because the people already are reacting and driving less while the average car burns less expensive petrol than some years ago.

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