Fueling the future

Fuel prices are all over the news lately, with Europe-wide protests of fishermen over the rising cost of fuel and truck drivers on strike. Everybody has been hit hard by the near exponential rise in oil prices recently. People are demanding tax cuts on fuel and maybe even subsidizing, while Sarkozy and the Hungarian government among others are flashing such ideas in face of the EU. Luckily such demands fall on deaf ears. Subsidizing fuel and tax cuts are nothing but a short term solution, with the negative effect of keeping demand up in a market where the growth in supply is practically nonexistent. By the looks of it, the EU seems to understand this. Looking at the nice exponential graph above, one can not stop to think about the reasons behind the sharp increase in prices. Of course there seems to be some correlation with global events, speculation has its role to play in this. There is a sort of a catch 22 situation, with high fuel costs driving inflation and investors using oil (and other commodities) as a hedge against it, which in turn accounts for a further rise in the oil price. But is that the whole picture?

As a general rule the price is defined by supply and demand. If supplies are short, demand goes down and prices go down with it. If so, then why aren't we seeing the oil price ease off? Why are price forecasts in constant need of upward correcting? And possibly the most chilling question of all: where will the price stabilize? It is very interesting to note at this point, that oil demand in the whole of OECD has been declining gradually for 3 years in a row according to the International Energy Agency. The problem it seems, lies with the emerging economies of Asia, whose thirst for oil fuels the overall growth in world demand. But as economist Jeff Rubin pointed out at the 2007 ASPO conference (see video below) this is not the whole picture. The reality is, that demand for oil is increasing rapidly in developing countries and in oil producing countries themselves, like Venezuela, Saudi Arabia, etc. These countries along with a large portion of the world subsidize fuel. Thus, effectively protecting their consumers from the world market price of oil. A person filling up at a pump in Caracas, or Riyadh never feels the 135$/br crude oil price. This is why demand is seemingly ignoring supply, driving up the price.

Recently the G8 have voiced their concerns about fuel subsidies, but the elimination or decrease in subsidies is almost equal to political suicide. Such reforms are very hard to implement. Even if there is political will, measures like this are very hard to swallow by people accustomed to cheap fuel. Just how hard this can be is nicely illustrated by recent events in Malaysia.

I can understand the concerns of people in Malaysia or Spain, etc., when they are witness to the decline of their businesses, but people must understand that deep down the cause of this shortage is natural and the governments of the EU, Malaysia, etc. have little to do with it. Oil production in most counties has already peaked in its production and what surplus OPEC has is used up by rising domestic consumption (see video below). The fact is, that we will have to learn to live in a world where cheap oil and cheap fossil energy is a thing of the past.