Tuesday, March 08, 2005

Defying gravity

Everybody who knew anything on Wall Street knew for certain that oil prices were coming down this year. Crude prices lept in 2004 for a number of one-off reasons: Iraq, an overheated China, terrorist attacks, OPEC cuts, a weaker dollar. But that's all in the past. Now we're back to normal. Inventories are building. OPEC is adding supply. Iraq has had its election. But wait, prices are still going up. The puzzlement is detailed by Reuters and CBS Marketwatch in the usual fit of cluelessness that passes for business reporting.

Every Economics 101 student knows that in a perfect market prices are determined by supply and demand. But oil is not and has never been a perfect market. I believe that current prices no longer merely reflect current supply and demand, but rather the view among some market participants that future supplies will not be so plentiful. Long-dated futures prices for crude have risen in concert with nearby prices. People are beginning to hoard. Once the cycle begins it's hard to know where it will stop.

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1 comment:

WHT said...

The other theory says that price swings become much more wild as you hit inelasticities in supply vs. demand. See for example the silver market.