Tuesday, December 4, 2007

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Why have oil prices gone up?

In the wake of the latest NIE suggesting that Iran's nuclear program has been frozen in carbonite since 2003, I would have expected oil prices to have fallen. After all, the obvious fallout from the estimate is that neither military nor enhanced economic sanctions will be imposed on Iran anytime soon. If one reason oil prices have spiked is increased political uncertainty, then surely the inteligence finding should have ameliorated these fears.

Imagine my surprise, then, to see that oil prices rose yesterday. Furthermore, the AP report has no mention of the Iran situation, discussing OPEC machinations instead.

This could mean one of four things is true:

1) Oil traders are slower at working through geopolitical ramifications than your humble blogger;

2) Oil traders are so smart that they already knew Iran's nuclear weapons program had been frozen, and had therefore already priced in expectations that the U.S. would eventually discover this fact.

3) Political factors are not as important in influencing oil prices as some commentators believe.

4) The NIE will have zero effect on the expected probability of the Bush administration's decision to use force.

I'm 99.99% sure the answer is not #1 or #2, and I'm 90% sure the answer isn't #4. But #3 seems inadequate to me.

Readers are encouraged to proffer their own answers.

posted by Dan on 12.04.07 at 12:27 AM


Perhaps oil consumption in China, India, and elsewhere is projected to keep increasing. I don't see why oil prices should ever decrease until (1) worldwide demand drops or (2) more alternative energy sources become available. Perhaps economic factors outweigh political factors in this instance.

posted by: Joel on 12.04.07 at 12:27 AM [permalink]

I agree with Joel above. But also, in reference to your point #3, I think political factors have a big impact, but only when speculators want them to. If there is a trend toward higher price speculation a political problem will spark a significant jump in prices. But if there is a trend toward higher prices and a positive development in politics that would seem to lower prices, the political development are not the important factors they seem to be.... Similarly, if there was a trend toward lower prices, then a positive political development (i think) would have a greater impact towards lower prices.

Overall, as Joel said, demand and supply are the key factors. But there is a complimentary relationship between price, speculation and politics.

posted by: Joe M. on 12.04.07 at 12:27 AM [permalink]

Don't underestimate #4.

Many already dismissed the probability of US action against Iran's nuclear program. Those who had been factoring that in can easily dismiss the NIE's relevance, since it reveals no new facts and can therefore be disregarded as guesswork from an operation with a record of guessing badly on WMD program statuses.

posted by: John Bragg on 12.04.07 at 12:27 AM [permalink]

I'm pretty much in 100% agreement with the OP.Why should projections of China's/India's future energy consumption rise yesterday, rather than some other day? Everybody knows they eat oil, and will eat more, and they knew it a week ago, too. Similarly, re: Mr. Bragg, everyone knows that there are insane people on the President's payroll. This, too, was known a week ago. How does the NIE change any of this?

posted by: foolishmortal on 12.04.07 at 12:27 AM [permalink]

Hi -

You miss an additional option:

5) Trading on commodity markets is only partially determined by supply and demand, with the difference being mob psychology. Traders are people as well, and their skills are limited to understanding their markets. Confronted by a threat to one aspect of their market - supply or demand - they will tend to significantly overreact, depending on how much money they anticipate being able to earn.


posted by: John F. Opie on 12.04.07 at 12:27 AM [permalink]

6: There is at least some suggestion that oil production is reaching a plateau level, which means future oil will be vastly more expensive.

And don't discount 4, you could have said the saem thing after the UN inspectors came up blank in Iraq...

posted by: Nicholas Weaver on 12.04.07 at 12:27 AM [permalink]

1) The price of crude oil rose less than 1% yesterday. It is a VERY bad idea to try a look for an explanation for a tiny daily fluctuation in a volatile market. All practical models of oil prices will treat it as simply noise (neither statistically nor economically significant), and you should ignore journalists' quixotic attempts to find a story behind the change.

2) The longer run increase in oil prices over the last few years can be explained almost entirely by increasing demand (particularly, but not exclusively, by China). Politically induced supply fluctuations are simply dwarfed by the changes on the demand side. As per Econ 101, if both prices and quantities are increasing, you can rest assured that demand-side changes are dominating supply-side changes. And that definitely describes world oil markets today. See http://www.eia.doe.gov/emeu/international/oilprice.html for various oil price data and http://www.eia.doe.gov/emeu/international/oilconsumption.html for consumption quantity data.

posted by: Steven on 12.04.07 at 12:27 AM [permalink]

You could also add another positive political development: Hugo Chavez was defeated in an election.

I spent many nights learning the oil market, not as an academic hobby but intensely motivated by greed, and my impression is that no one understands it.

posted by: jaim klein on 12.04.07 at 12:27 AM [permalink]

A possible alternative explanation is that demand for oil is not independent of politics.

Reduced likelihood of war increases optimism about the future, which increases expected economic growth rates, which increases expected demand for oil, which places upward pressure on the price of oil.

If the effect of increases in expected demand is larger than the effect of reduced risk premiums oil prices will go up, not despite of the reduced risk of war, but because of it.

posted by: Deepish Thinker on 12.04.07 at 12:27 AM [permalink]

The stock market fell yesterday too. This means that either traders weren't pricing in the risk of a war with Iran or they don't think that risk changed. Curious.

posted by: KenS on 12.04.07 at 12:27 AM [permalink]

While the report may decrease fears of external conflict the fact that the Mullahs have not been making weapons may weaken their internal power which makes internal instability more likely -- an offset to the "good news."

posted by: Kris Kringle on 12.04.07 at 12:27 AM [permalink]

Ask BDM if he still uses his forecasting model to speculate in oil futures. If so, ask him if he's in the market. If so, ask him why and see what he says.

Couldn't hurt, and might be interesting.

posted by: arthur on 12.04.07 at 12:27 AM [permalink]

Or 5. Oil traders have figured out that the degree of actual leverage the U.S. will be able to bear on Iran is nil, when considering that Iraq and Afghanistan have defanged us from undertaking any military action and Russia and China will water down anything done politically. The bottom line is the U.S. does not matter as much as it used to pre-2003 and the NIE will not move the market like it would have 4 yrs ago.

posted by: Dimitri on 12.04.07 at 12:27 AM [permalink]

It seems clear to me that No. 3 is operational, with the caveat stated by JoeM -- that political factors can have an impact when traders decide they should.

A question: Has anyone else developed whiplash from the diametrical shift in the official view, with no pause for reflection? I realize this is an obvious observation, but it's nevertheless jarring that at one moment we must must must go to war with Iran because of its imminent nuclear program, and the next can breathe a sigh of relief because it actually stopped developing one four years ago.

That fact -- in addition to everything else -- makes one even more dubious of the administration's judgment.

Steve LeVine, author
The Oil and the Glory (Random House)

posted by: Steve LeVine on 12.04.07 at 12:27 AM [permalink]

By the way, you may have noticed this article from the BBC:

Oil prices slide on Iran report

Oil prices have fallen about $10 in the past week
Oil has fallen below $88 a barrel, losing ground after a US report downplaying Iran's nuclear ambitions had eased geopolitical concerns.

US light sweet crude fell $1.71 to $87.60 a barrel in New York, while a barrel of Brent crude dropped 63 cents, to $89.17 in London......

posted by: Joe M. on 12.04.07 at 12:27 AM [permalink]

5) The new NIE, while applicable to the threat of imminent nuclear blackmail from Iran, does not in fact reduce the risk of Iran cutting off regional oil exports by other means. In other words, it does not change traders' assessment of Iran's intent and capability to disrupt, only their expected means to that end. (From an oil price point of view, 100% disruption is as bad as it gets, and "descent into years of anarchy" may well be worse, oil supply wise, than "stable nuclear blackmail detente.")

6) The oil traders don't believe the NIE.

-- perry

posted by: Perry The Cynic on 12.04.07 at 12:27 AM [permalink]

Because Bush is still Bush:

Biden said the Senate vote and Bush's subsequent declaration that the Iranian military unit was a terrorist group had been disastrous.

"The moment that declaration was made, oil prices jumped over $18 a barrel. The moment that declaration was made, every one of our friends, from Iraq to Pakistan, felt they had to distance themselves from us because it appears to be a war on Islam," Biden said.

posted by: Politics Dude on 12.04.07 at 12:27 AM [permalink]

You know I'm willing to cut Biden some slack because of his plagiarism in law school (don't see how that gives him a seat, much less a chairmanship on the Judiciary Committee.) But that was a remarkably stupid statement. The IRGC's
propensity for warfare has been seen in it's liason with Hezbollah directing the attacks on American targets in Beirut and Kuwait, Iraq, Buenos Aires, Vienna, et al.

posted by: narciso on 12.04.07 at 12:27 AM [permalink]

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