Monday, December 27, 2004

The Gathering Storm?

Philip K. Verleger is an energy consultant. I found an abstract of his paper on the Institute for International Economics web site. His argument is that there are six major driving factors behind the current instability in the oil markets and could drive the price of oil steadily upwards unless action is taken to address these structural factors. The six factor identified by Dr. Verleger are:

• Demand for oil driven up by increased consumption in China and India.
• Failure of OPEC and other players in the oil business to anticipate the increases in demand and adequately invest in increasing capacity.
• Political instability in several oil producing nations.
• Lack of investment in downstream business operations, specially in the refineries.
• Stricter fuel regulations in Europe and US limiting the production of different outputs of the crude oil.
• Lack of adequate efforts on energy conservation since some how there is a notion that the prices will come down sooner rather than later (or never).

These six factors pretty much cover the entire territory on high oil prices, although I keep hearing that the continuosly increasing US trade deficits which are resulting in a weaker dollar is also one of the causes. I do not have enough knowledge of macro economics to argue in favor or against this one.

Dr. Verleger thinks that these factors have led us to a point where we may be facing a crisis on a global scale in terms of energy prices. His suggestions for avoiding a price shock are:

• In the short run, the major oil producing and consuming nations should come together to agree on a stable price zone for oil. This is easier said than done.
• In the long term, however, there is no alternative to reducing the rate of growth of demand for oil. Interestingly enough Dr. Verleger refers to Amory Lovin's Winning the Oil End Game strategy as well as Thomas Friedman's Patriot Tax.

Overall, there are enough arguments that support my hypotheis that the oil prices will remain in $40-45 range for the next few months. So forget about the dream of buying gas for your 2005 memorial day drive at $1.60 a gallon.


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