Monthly Discussion


Who Is Pulling the Strings on the Price of Oil?

There is agitation around the price of oil recently. The fact that it doubled since the beginning of the year has triggered rampant speculation. One of the central concerns, of course, is who exercises control over the price of oil, assuming that control can indeed be exercised.

I will not review here fundamentalists' scenarios invoking such prime movers as OPEC decisions, sanctions lifting, and diminishing reserves. Instead I will add one more possibility that may ring a familiar bell to those of you who read my first book Predictions.

Energy is the ultimate food for life, and that makes the price of oil something next to being sacred. Doubling the price of bread in a large poor country could result in a popular uprising, or trigger a revolution. Society on the other hand has ways of safeguarding its survival. It has been argued that society possesses wisdom that surpasses the wisdom of its individual members. It then makes sense to expect that society manage to maintain the price of primary energy rather stable over time.

The graph below shows the evolution of the price of primary energy in the Unites States during the last quarter of this millenium. As we are concerned with primary energies, eighteenth-century data are dominated by the price of coal while the better part of the twentieth century by the price of oil. What is striking in the figure is that apart from periodic flare-ups (rather regularly spaced by the way!), the price of energy has been confined to a narrow range, lets say $10-$20 1996 dollars.

Exhibit 2. Annual averages for the price of energy are obtained from two different sources for the two curves indicated. Fuel and lighting prices from Historical Statistics of the United States, Colonial Times to 1970, vols. 1 and 2, Bureau of the Census, Washington, D.C. Oil prices from the West Texas Research Group, LLC,

An earlier version of this figure is discussed in Predictions where society is shown to depict periodic "moods" associated with the price flare-ups. These "irregularities" coincide with a turning point in the evolution of the market share of a primary-energy source. Oil alone provided close to 50% of the world's energy needs during the 1960s and the 1970s. But in the 1980s oil began losing market share due to the rising use of natural gas. At that point in time oil prices shot up manifold over a couple of years. Something similar happened to coal when it began losing ground to oil 56 years earlier.

Fundamentalists argue that the 1981 price rise was caused by the Iran/Iraq war. In fact, the West Texas Research Group publishes many graphs of oil prices, annotated with the occurrence of world events, intending to point out cause-and-effect relationships. But these are after-the-fact scenarios. One can always go back in history and search for "significant" events around a date of interest, while ignoring other "significant" events that occurred further away (for example, why wasn't the Gulf war important?)

The way of thinking presented here is more fundamental than the fundamentalists' approach. World events may trigger but cannot create a significant price change. The price of primary energy is auto-regulated. The next important price flare-up won't be before at least a couple of decades. Kondratieff's economic cycle tells us that prosperity should reach a zenith in the mid 2020s and begin a downturn in the early 2030s. Energy-price flare-ups have traditionally punctuated the end of boom years (world economy entered a major recession within ten years from each one of the four peaks in Exhibit 2).

So there will be some social or political event that will seem "responsible" for energy prices going up a factor of 3, 4 or 5, toward the end of the first quarter of the 21st century. But even then it will mostly concern the price of natural gas, because by that time natural gas will have replaced oil as the major primary energy source worldwide.

In the meantime, we can expect oil prices to generally remain inside the $10-$20 1996-dollar range, or corrected for inflation, $10.5-$21 of today's dollars. We can also expect natural gas to be playing a progressively more important role in everyday life. If natural gas is to carry the load of providing the world with energy by the mid 2020s, gas stations should be outfitted with natural-gas pumps in the next 5-10 years.