Why are Oil Prices so High? An Energy Primer

10/21/2008 Update:Supply and Demand have now driven prices down significantly, as fears of a global depression, and reduced driving worldwide, have led to decreased use of oil. How significant was speculation in the runup to $147 oil? Certainly it played a part, just as speculation played a part in the dot com boom and the housing bubble. But oil is still up 700% from its lows around the turn of the century, and that’s due to the fundamentals explained further below.

05/22/2008 Update: As this article has become far and away my most-read, and since oil is now cruising towards $140 a barrel, I thought an update was deserved. For those without the time to explore the links below, oil is rising for a simple reason: oil production has not risen significantly since 2005, while demand for oil worldwide continues to rise rapidly. The simple law of supply and demand is moving oil prices up, and no number of Congressional hearings will change that.

With news of crude oil prices topping $110/barrel today, it’s no surprise that the price of gasoline and oil are once again on people’s minds. As an introduction, here are a few links on the global transportation energy (oil) situation today, and on various risks that we might face in the future.

What is Peak Oil? – This Wikipedia article on peak oil outlines the notion that oil production must someday hit a peak, since oil is a finite resource drawn from Earth’s crust.

Export Land Model – Jeffrey Brown, an independent oil geologist, and others at The Oil Drum provide insight into the effects of a simultaneous plateau or drop in oil production coupled with rapidly rising oil consumption in oil exporting countries. The ELM is a simple model that graphically illustrates some of the forces driving energy prices rapidly higher.

Matt Simmons on Peak Oil and the future of oil production – Matt Simmons is an energy investment banker made famous by his book Twilight in the Desert, and here he offers his (mildly pessimistic) outlook for the future of world oil production.

The Oil Drum: December 2007 Production Forecasts and EIA Oil Production Numbers – For those interested in the hard numbers and in quantitative forecasts, there are few places better than The Oil Drum as a starting point.

CERA Peak Oil RebuttalDaniel Yergin’s energy consultancy CERA issued this rebuttal on peak oil in late 2006. It is worthwhile to note that even CERA’s rebuttal implies that there will be an eventual maximum rate of oil production, which in the face of rising demand implies higher prices in the long run.

3 thoughts on “Why are Oil Prices so High? An Energy Primer

  1. Interesting article. One of the things I have been concerned with is the strain that oil will put on the economic ”recovery.” Even though these one off situations like Egypt, Saudi Arabia, and Japan will have a short-term effect, the long-term trend is what I am most concerned about. What is interesting is that in several areas that have been hit hardest the following circumstances are all happening at once.
    In most of these areas (Phoenix, Las Vegas, Inland Empire) , housing prices have crashed, leading to underwater houses and eventually foreclosures. Unemployment has skyrocketed in these areas as well. Now that prices have fallen so far and inventory appears to some to be ripe for the picking, investors are purchasing properties for to rent for cash flow. However, as oil picks up, it is becoming clear that many of these desert communities are not sustainable as they rely on cheap oil as many of the cheapest surrounding areas are commuter communities. The uncertainty is tremendous in these markets, yet many investors are jumping in and gobbling up properties.


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