Oil Price Fluctuations
Posted by Max Dunn Mon, 03 Nov 2008 22:36:00 GMT
Oil went up to $147 per barrel and is now down to $64. Does this mean that the oil shortage is over and that we can go back to driving SUVs? No, not unless you can afford to drive your gas hog when the price of gas goes back up over $4 per gallon. Actually, this type of wide oil price fluctuation is to be expected.
The reason for these fluctuations is the inelasticity of both the supply and demand for oil. On the supply side, nowhere in the world is it possible to just turn up a tap and pump more oil – everyone is pumping as much as they can. (Saudi Arabia and Iran do have extra capacity for heavy, sour crude, but that doesn’t help.) So in order to increase the supply of oil, it is necessary to drill more wells or employ advanced extraction techniques, all of which take time.
On the supply side, demand is very inelastic as well. When the price of gas goes up, you don’t immediately ditch your SUV and buy a Prius or find a job closer to home. In the short term, you still need to drive to work, take the kids to school and heat your house, so you pay whatever it costs.
So now we have an inelastic supply meeting an inelastic demand and what do you get? That’s right, wildly fluctuating prices! As soon as demand creeps just a little bit above supply, the price shoots up. Then when the supply goes up just a little, and demand goes down just a little, prices fall.
This is a classic pattern and one that we have seen before with whale oil. Whale oil mimics closely what we are seeing with fossil oil in that techniques to extract it got better and better and overran the natural supply. As the supply started to peak, prices went through some wild fluctuations too:
So don’t be fooled by the current low oil prices. They are not a sign that all is well, but only a sign that the worst is yet to come.
(For more information, see Peak Oil and EVs)