The price of oil

There are sound economic reasons why the rising price of oil isn’t likely to threaten the still-vulnerable U.S. recovery, even though oil is expected to remain around current levels for months to come. That is little comfort, though, to American consumers and transportation-dependent industries that will be hurt by current prices. Given the wide impact of oil on a personal level in the United States, rising prices may have a political effect. Current oil prices are also prompting concerns about what energy costs may be farther into the future.

On March 31, OPEC decided to lower its production target by 1 million barrels a day, beginning April 1, anticipating a seasonal decrease in oil demand in the second and beginning of the third quarters. In the first quarter, the oil price averaged just above $30 a barrel. Energy analysts are quick to point out that the high price of oil is a matter of perception. Although it is unlikely to cheer consumers, the price of oil, in inflation-adjusted dollars, is lower today than it was 25 years ago.

The outlook on U.S. dependency on foreign oil is mixed. The United States imports about 60 percent of the oil it consumes, compared to about one-third in the early 1970s. For the past 30 years, the overall consumption of energy per capita has generally been flat. The United States consumes more oil, relative to its economic production, than Japan or Western Europe, but U.S. production has become more fuel efficient. Today, each unit of economic growth takes half as much energy to produce as it did in the early 1970s. Thanks to this decreased dependency on oil to fuel U.S. growth, the economy is better able to weather a rise in price, as evidenced in the current sustained recovery.

The question remains, though, why are prices so high? If oil producers allowed supply and demand to freely fluctuate, oil’s equilibrium price would be significantly lower than it is today. OPEC, which produces about one-third of the world’s oil, prevents prices from reaching that equilibrium price by constricting supplies.

For the foreseeable future, OPEC won’t face any economic impediments to its market manipulations, and oil, therefore, is expected to remain around $30 a barrel in coming months. These oil prices will likely be sustained by the world’s steady, relatively inelastic demand for oil. OPEC producers are able to sell virtually the same amount of oil at $12 a barrel as they do at $30 a barrel. It is in OPEC’s financial interests, therefore, to keep supplies tight enough to keep oil prices high.

Those realities make theories about an OPEC conspiracy to punish U.S. consumers for America’s Iraq campaign or other reasons probably unfounded. Also, Saudi Arabia has developed a budgetary dependence on an oil price in the high 20s, said Neil McMahon, an oil analyst for Bernstein Investment Research and Management. “Saudi Arabia needs that sort of level just to keep the country going,” he said, given their debt load and demographics. On the other hand, “they know that if they let prices reach, say, $50 a barrel, they risk invasion,” he added. Still, one market insider noted that while OPEC’s decision on March 31 was economic, there is a discernable difference in Saudi Arabia’s attitude toward its relationship with the United States.

Taking a longer-term view, oil prices aren’t expected to fluctuate significantly. By about 2010, oil is expected to be about $30 a barrel, according to Bernstein research. Around that time, OPEC producers are expected to produce as much as they can to meet global demand. After about 2020, though, maintaining stable energy prices will depend on major and timely investments to improve the yield of mature oil fields, innovating conservation technology or developing alternative resources.

Efforts to diversify foreign sources of oil are in U.S. interests, but aren’t expected to significantly counter OPEC’s market dominance. Technological innovation has decreased reliance on oil, bolstered oil extraction and significantly improved the efficiency of other energy resources, such as natural gas. It will probably continue to determine the stability of energy resources in the future.