May 22, 2008

Why does oil cost so much?

Previously I mentioned the impact of dropping dollar on the cost of oil. But today in the news I see that our Energy Secretary is blaming the increase in price on tight supply and then suggests we should open natural parks to oil exploration. I don't think that argument holds up to much scrutiny and I think its motivated by a desire to increase oil production.

Contrary to our energy secretary, here is a well stated article from Reason Online, : Oil Price Bubble? Supply is up, demand is down, yet the price is soaring. Here's why. It argues that there are 3 main reasons why oil is going up so much: 1) the weak dollar, 2) political turmoil, 3) speculation. You can read the article yourself for the details. It makes a good argument in my opinion.

I decided to look into the demand / supply situation myself. The Energy Information Administration (EIA) from the U.S. government has a lot of data on energy usage. From that site I found information on worldwide oil supply, worldwide oil demand, OPEC specific usage, etc. They have solid numbers up to at least 2006 and some stuff for 2007. I think this is the most recent published data available.

From the data I see, worldwide oil supply is keeping up with demand. From 1999 to 2007 world wide oil consumption went up 12.8% and world oil production went up 13%. The Reason article also then says that production went up 2.5% from the first quarter of 2007 to first quarter 2008 and consumption went up 2%. However, I will note that some years the production is a little less than the consumption. This could cause price increases. But I don't see any trend of that happening in the past. Consumption was more than production in 1999 and 2002 but oil didn't go up a large % in price those years.

Here is a graph that I made showing oil consumption versus production as well as oil prices in both US$ and Euros:

As you can see the consumption and production tracked each other very closely every year from 1999 to 2008. But prices didn't start going up that much until just recently in 2007-2008. To get the value of the Euro I used this Wiki page which quotes high/low annual Euro / USD exchange rates then I took an average of the high and low for each years figures.

Again, comparing the price in US$ and Euro is pretty revealing. While he price in US dollars has quadrupled in the past several years, the price in Euro has not increased quite as fast.

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