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May 4, 2006
CFR Explains Basic Oil Economics

The Council on Foreign Relations has released a short primer on oil economics to its website. After our conference call with ExxonMobil's Ken Cohen yesterday, CQ readers had many questions about the data Cohen provided us. CFR, a think tank on foreign policy and economics that tends towards the center-left, may have more credibility on this topic for some readers than an oil-company executive. Lee Hudson Teslik explains the effects of global supply and demand:

How does global oil supply affect the price of American gasoline?

Given the extent to which the price of crude oil affects the price of gasoline, any fluctuation in the world's crude market can have a significant impact on the gasoline market. In 1960, many of the world's largest oil suppliers formed an organization through which they could coordinate production and ensure consistent supply, thereby providing stability in an otherwise very volatile market. This group, called the Organization of Petroleum Exporting Countries (OPEC), now oversees over half of the oil supplied in the world. By coordinating production and output, OPEC wields heavy influence over the market price of crude oil.

Critics have blamed the organization for "squeezing supply" by limiting the amount of oil that is drilled and refined, thus keeping crude prices high at the expense of the world's oil importers. But others have argued that the only way to compel oil suppliers to bolster their output is to allow crude prices to rise, thereby providing the incentive for increased production capacity. Leonardo Maugeri, an executive at the Italian energy company ENI, recently wrote in Foreign Affairs that this is already starting to happen: "As market forces have kicked in, high prices have already started to generate more investment, which will boost both production and refining capacity in the future. In other words, high oil prices are a painful but necessary cure for the disease that has affected the oil market for about twenty years."

It is important to add that other factors, some out of OPEC's control, have also affected supply. These include political instability in major oil-producing nations, particularly Iraq, Iran, and Nigeria; concerns of terrorist attacks on pipelines and production facilities; and even the weather. Hurricanes Katrina and Rita, for example, caused a significant and painful price-spike in the United States. In this article, CFR's Senior Fellow in International Economics Roger Kubarych examines the market effects of oil shocks.

What about demand?

In addition to restricted supply, the world's oil market has experienced a recent spike in demand. This has raised the price of crude, and thus in turn the price of gasoline. The spike is a result of increases in demand in the United States, the world's foremost energy consumer, and of explosive growth in the oil needs of major developing nations. In 2004, China displaced Japan as the world's second largest oil importer. India and Brazil also have emerged as major oil consumers. These new markets have only exacerbated upward pressure on the price of crude. China's energy needs, and its efforts to explore new oil markets, particularly in Africa, are examined in this CFR Background Q&A.

The oil market really isn't that complex. Anyone with a basic education in economics and a few minutes to conduct research can garner an understanding of commodities markets and the mechanisms that influence price. Some people prefer to assume big conspiracies rather than make an effort to learn the facts, it appears.

Sphere It Digg! View blog reactions
Posted by Ed Morrissey at May 4, 2006 9:19 PM

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