The Real Reason Behind Oil Price Rises
Weekend reading on oil prices. Oilprice.com was fortunate enough to speak with the world’s leading energy economist, Professor James Hamilton. James is a professor in the Economics Department at the University of California, San Diego. (via Doug Short).
Interview conducted by James Stafford of Oilprice.com
James Stafford: Oil prices have shot up in the last month. What range do you see oil prices trading in over the next 12 months?
James Hamilton: Oil prices have always been very volatile. If you look at 12-month logarithmic changes in WTI going back to 1947, you come up with a standard deviation of 0.27. In other words, 25% moves up or down within a year are fairly common, and 50% moves or greater have also been seen on a number of occasions.
If you look at options prices at the moment, they imply the same level of uncertainty looking forward. For example, somebody today is willing to pay $2.90/barrel for a NYMEX option to buy oil in September 2013 at $120/barrel, consistent with a standard deviation of annual log changes of 0.26. The market is saying that prices that high or higher are not that remote a possibility.
And if you look at current fundamentals, it’s not hard to imagine big moves in either direction coming fairly quickly. The price of oil would surely collapse if we saw a significant economic downturn in China (something nobody can rule out) or if Iraq succeeds in producing even half of its ambitious production targets (though I personally consider the latter unlikely). On the other hand, a military confrontation with Iran could produce a pretty spectacular price spike. If the Strait of Hormuz were to close, for example, it would represent a shock to world production that in percentage terms would be 3 times as big as the 1973-74 OPEC embargo.
Because the demand for oil is so insensitive to the price over the short run, and because there is little excess capacity in the world at the moment, even small disruptions or additions could produce big price changes. For this reason, I do not have a lot of confidence in anybody’s near-term oil-price forecasts.
On the other hand, I think we understand pretty clearly the main factors behind the overall increase in oil prices since 2005. Demand for oil, particularly from the emerging economies, has grown significantly, and we have had a hard time increasing global production. The single most likely outcome is that both conditions will continue to be with us. The most likely scenario is that the next decade will look something like the last, with oil prices volatile but exhibiting an upward trend.
Full interview here.