Why are oil prices so high?

by Rob Horning

29 May 2008


Why are oil prices so high? The obvious answer would seem to be because we are running out of it. Peak-oil enthusiasts have argued this for years, but the idea is creeping closer to the mainstream. In the New York Times Paul Krugman argued that prices were based on fundamentals of supply and demand in this column from a week ago. He was responding to the idea that commodity speculators are wreaking havoc on the natural play of economic forces, an argument that fund manager Michael Masters recently presented at a Senate committee hearing. He blames “index speculators” among institutional investors, whose demand for oil futures rivals China:

According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels.8 Over the same five-year period, Index Speculators’ demand for petroleum futures has increased by 848 million barrels. The increase in demand from Index Speculators is almost equal to the increase in demand from China!

At his blog, Steve Waldman takes an elaborate look at Masters’s view and asks this pertinent question: “But what if the price-setting speculators are not momentum-driven index funds, but ‘traditional speculators’, correctly predicting that prices are below long-term fundamentals? Then limiting commodity speculation would prolong the mispricing, and cause us to waste resources that are kept artificially cheap.” In other words, we would keep wasting fuel because regulators would be keeping its price artificially stabilized (kind of like they do in Venezuela and Indonesia).

Of course, there are high political stakes in this argument: if it’s speculation and not peak oil that’s driving prices, then we needn’t worry so much about conservation or build any expectation of permanently higher fuel prices into our economic decisionmaking. That would make American automakers happy, at least, and supply political demagogues with an easy target as Americans suffer through “the summer driving season” paying prices at the pump ($4+ a gallon) that they have never dealt with before. As Krugman points out,

Traditionally, denunciations of speculators come from the left of the political spectrum. In the case of oil prices, however, the most vociferous proponents of the view that it’s all the speculators’ fault have been conservatives — people whom you wouldn’t normally expect to see warning about the nefarious activities of investment banks and hedge funds.

Why? Because the conservatives want to pretend America, in its glorious exceptionalism, need not change a thing about its wasteful behavior.

The surprising shift Krugman notes could actually be seen as the return of the old alignment of economic liberalism with political liberalism on one side, and economic conservatism and government intervention on the other, as it was before the Industrial Revolution, when society’s elites (if you accept Polanyi’s thesis in The Great Transformation) attempted to forestall the market’s overwhelming society and all its established mores. In this sociopolitical configuration, conservatism is not about guaranteeing a free market but about preserving the existing distribution of power. For a while, a free market served that end, but conservatives have never cared about freedom per se. Our coming energy problems may make then more than abundantly clear.

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