————————————————————————————————

Monthly Discussion

Iraq and the Price of Oil

The price of oil has been discussed in Predictions and then again in earlier issues of this Newsletter. In all occasions the main conclusions was “business as usual” meaning that the price of the world primary energy source is something of a sacred cow and cannot deviate significantly from its equilibrium position for extended periods of time.

It was pointed out in Predictions that energy prices flare up multifold toward the end of economic boom periods as defined by the Kondratieff’s cycle. At all other times energy prices remain rather confined to a homeostatic level, a position of equilibrium well tolerated by society. This conclusion is based on energy-price data spanning almost a quarter of a millennium, see Exhibit 3.

The time frame in Exhibit 3 scans several centuries and the primary energy source is not always the same. During the 18^th century it was mostly wood and animal feed. In the 19^th century it became mostly coal, and in the 20^th century mostly oil, particular during the second half of the century. Consequently, Exhibit 3 shows first the price index for fuel and lighting normalized to 1926, and then oil prices normalized to 1996 dollars. Huge spikes stand out at the end of each economic boom of the Kondratieff cycle.

The cyclical pattern of the price variation is not perfect. The 1864 peak is one fourth as important as that of 1813 and the width of the 1864 bump stretches over a dozen years. And yet, looking at Exhibit 3 leaves no doubt that there are regularly spaced price flare-ups. Their periodicity being exactly that of the Kondratief cycle implies deeply seated roots for this phenomenon. Under what circumstances then should we expect a significant deviation for this pattern?

The spikes are so pronounced compared with the usual day-to-day price fluctuations and are so regularly spaced that they inspire confidence in setting forth some daring forecasts. That is what I did in Predictions and I quote:

Neither price-fixing nor hostilities among the oil-producing countries should succeed in raising oil prices to the 1981 levels for longer than a few months at a time. The price of oil will stay around 20 1996-dollars a barrel well beyond the year 2000. Energy prices are due to hit a high again around 2030 and will mostly reflect the price of natural gas, which will be the dominant energy source of the time.

Ten years later we see that the forecast was more or less correct. The price remained around 26 1996-dollars for most of time. In fact, even during the Gulf war, when oil prices hit 40$ per barrel for a while, things were back to “business as usual” by the end of the year. A small price bump is visible around the Gulf-war time but by and large the oil hike is hardly noticeable in the graph. The same is true with World War II; deviations in the oil price trend are barely noticeable. The big price flare-ups have been regularly spaced 56 years apart on the average.

Exhibit 3. This is a drawing from Predictions updated here to the end of 2002. We see price indices from different sources. The price of oil is expressed in constant 1996 dollars. The red dots indicate oil prices for January31 and February 14, 2003.

One may want to see a deviation from the cyclical pattern emerging recently in particular from year 2000 onward. The first two months of 2003 (see red dots in Exhibit 3) extend this deviation to substantial levels. But I believe that by year’s end (with the war hopefully finished) the price of oil will be back to $20 1996-dollars. One will be then able to look back and say that “some phenomenon” recently disturbed things a little more than the Gulf War of 1991. But this disturbance began before the 911 events and ended when the Iraq War ended, so it can hardly be attributed to Iraq.

Other than the short term (next few weeks or months) Iraq’s impact on the price of oil will be minimal.