More on the Oil Price

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In 1997, the world consumed almost 74 million barrels of oil. In 2002 this had increased to 78 million barrels of oil. This year, the amount consumed will reach 86 million barrels of oil. The oil price in January 2002 was $20 per barrel. This month it's trading at around $75 per barrel.

The increase in consumption from 2002 to 2006 was 10.26%. The increase in the price from 2002 to 2006 is 275%. So it's not demand that's moving the price, it's speculation based on the fear that supply will be disrupted (due to wars, strikes in Nigeria, Hugo Chavez teasing the Americans etc).

Juicing up the speculation has been the easy money regime the globe has experienced since 2002. The US Fed funds rate was 1.75% in Jan 2002, and fell as low as 1% in mid 2003. Rates in the euro-zone hit a low of 2% in 2003, and rates in Japan were 0% throughout the period, until last month, when they rose to 0.25%. For a speculator, borrowing at 0% or 1%, is essentially free money, and the money was being invested speculatively (i.e. with no intention of taking delivery) with returns of nearly 300%.

Central banks around the world have been removing the easy money in a steady and determined fashion. As it becomes less cheap to borrow, the speculative element of the oil price should drop (and of course higher interest rates will also slow the global economy, reducing demand for oil). The weakest link is still Japan as a 0.25% rate is still practically free money. You could argue that the world economy is more influenced by Japanese monetary policy than by US policy (but that's a post for another day.

I've included two graphs in this piece. The first shows the oil price from 1947 to 2004, with the world events that affected it, (the oil price has since increased to $75, taking the red line up and off the chart). The second shows the oil price since 1869, adjusted to 2004 dollars (i.e. adjusted for inflation). Oil is still cheap when you take inflation into account.