There was an interesting post at VoxEU the other day that got discussed at Free Exchange, but not here. The author, Lutz Killian, examined the market for gasoline in America to try and figure out why prices had increased. The answer, in a nutshell, was that crude oil price increases were the biggest factor, and oil prices have been rising because of growth in Asian demand. This means that speculation hasn’t been playing a big role. More interesting, it seems that supply disruptions from things like pipeline attacks in Nigeria don’t really affect oil prices (although refinery disruptions in America do have short-term effects on gasoline prices).
Another interesting thing to note before moving on–constrained oil supply, according to the research, is more about the very long lead times for new investment than shrinkage in the physical supply of oil. That doesn’t mean the latter isn’t a factor, however. The long lead times for new investment wouldn’t be important if we hadn’t already pumped most of the easy-to-get-at oil.
Ok. So you may have noticed that oil prices have come down in the past couple of weeks, as have gasoline prices. What does that mean, and can we expect more of it? It’s difficult to say anything with any certainty, but I suspect that the recent decline in prices is mainly to do with changing expectations about global, and particularly Asian, economic growth. Growth is slowing, but governments around Asia are also showing a strong commitment to fighting inflation. Interest rates are rising around the region, often very rapidly. The big economic hot spots are going to cool a bit, and so markets are adjusting their view of demand for oil.
Will that continue? Again, it’s difficult to say, but I think that we can’t expect a huge drop in Asian growth or big dips in oil prices. Growth is the primary concern for a number of the region’s governments, some of which depend upon it for their legitimacy. A falling oil price is also self-limiting. Cheaper oil means higher real incomes and reduced inflation, both of which are likely to get growth moving again. With supply tight, any move back toward expansion will immediately translate into higher prices.
In other words, we’re likely to stay within a certain range for a while. Prices can’t get too much higher without substantial demand destruction and growth-slowing disinflation policies. They can’t get too much lower either, without the vanishment of drags on growth kicking in and supporting demand.