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Arab crisis: plunging oil costs

Anthony Randazzo
September 10, 2008, 7:53am

The OPEC oil cartel met Wednesday to discuss their most recent crisis: plunging oil prices. Never mind that one year ago oil was $20 less than it is right now, two months ago it was soaring, and many nations are concerned about their rapid loss of profits. In a move to try and stop the hemorrhaging, they've cut back production by 500,000 barrels per day. The theory is simple: less supply with sustained demand will raise the price. Initially the idea was working Wednesday morning as oil rose to over $104 per barrel. The price fluctuated before dropped down to $101 early Thursday morning. The actual role supply and demand play into the price of oil is unclear, as much of it seems to be driven on speculator comfort. Lately there has been positive news out of Iraq, an agreement between Europe and Russia over Georgia (again), and a general sense of calm not to mention a growing (though slowly) U.S. economy that has yet to hit recession. Saudi Arabia has expressed concern that too highly priced oil will shift demand for fuel elsewhere. The high cost of gasoline has spurred on the hunt for alternative energy in American and promoted oil drilling in the Western hemisphere. Both initiatives set an ominous horizon for Arab nations dependent on American money. Economists understand that supply and demand determine price in a normal market. However, if the decreased production of oil does not raise the price then we must consider two possibilities: either demand is decreasing with decreased outputs, or speculation has a much heavier guiding role in the price of oil than many economists would like to admit. Considering that the reduced price a the pump is unlikely to scare drivers away and thereby decreasing demand, I think we'll find a much clearer demonstration of oil speculation realities in the coming weeks.

Anthony Randazzo is Director of Economic Research


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