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Oil prices

• Evan Davis | Notes on Real Life |
• 10 Nov 07, 08:54 AM

Imagine. $100 dollars. It is a lot for a barrel of oil. In fact, it's way up there.

Since the 1860s, when people stopped killing whales for oil and dug it up in Pennsylvania instead, the price has averaged a little over $25 a barrel in today's money. We're at four times the long term average price.

And as recently as 1998, only nine years ago, oil - on some measures - dipped below $10 a barrel. Although in today's money, for the year as a whole the price was more like 17.

It's clear that $100 a barrel is very high. Although it's worth saying, it's still not a record.

1864 was in fact the most expensive year for oil. It was over $104 in today's money. Notwithstanding that record (and most of us in the media will ignore it when talking of record highs in the next few weeks - we'll be using the high of $104.7 reached in 1980 after the Iranian revolution) we can at least say an impending $100 barrel is getting historically significant.

One does have to wonder why the price fluctuates so enormously… it makes the housing market look stable.

Well, there are several oddities that drive the oil market.

Geo-politics is one - Iran has a tenth of the world's oil reserves, so you can't ignore what's going on there for example.

Geo-economics is another factor - the falling dollar means oil prices are not rising in euros and pounds as fast the dollar price suggests.

Finance matters too - the oil price doesn't just depend on oil, it also depends on bits of paper called derivatives that are bought and sold by people trading in oil. That can exacerbate price movements.

Each of these might be adding 10 or more dollars to the current price of oil. But you can't pin the price or the volatility of the price just on those.

The economics of supply and demand ultimately play the largest part, the demand of China in particular at the moment. As a rule, its economy is growing much faster than its oil consumption, but that still leaves its oil consumption growing very fast.

And there's a simple rule about commodities - a small gap in supply and demand can lead to a big swing in price.

After all, if there's 1% too little oil in the world for current demand, the price needs to rise. But there's no reason to think the price needs to rise by just 1%. It needs to rise enough to persuade 1% of the users to switch - and that can be a lot more than 1%.

But the point of volatile market is that it swings both ways.

The longer we have higher oil prices, the more we can economise on oil - by switching to smaller cars for example. And the more oil that gets produced – a small excess of supply over demand - and the price can plummet.

The lesson of history, is that when oil prices soar up to record levels, they usually then fall back down.

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