Well…my last serious post on oil prices can be found here. Back then, oil was at $80 a barrel. Since then, oil went up to $147 and is now at the mid forties after dropping all the way down to $30. Does economics explain this phenomenon? Well, lets have a go with that most amazing of tools, hindsight.
The total demand drop from 2006 to today ranges between 2 and 2.5% . Assuming that the predictors were expecting a gain of 1.2% yoy (a reasonable prediction), the notional demand drop would then be about 5%.
At the same time, production has increased by about 1.5% over the same period.
In this period, oil prices have risen to $140 a barrell from about $40 and have come back down to about $40 a barrell. Can conventional price Elasticity explain this?
Even assuming the widest variations in demand and supply, we have about a 6% variation in demand and supply. This ^% variation has led to a price change of almost 300%. This would mean that demand and price have a multiple of 50. By my previous calculations, the multiple was closer to 10 than 50.
So economics does not seem to completely explain this massive change in price. But what if the underlying multiple of 10 was also leveraged?
The theory behind perfect marketplaces is that more players there are, the more clearly the price in the marketplace would be provided. However, in oil, the actual deliveries are fairly small compared to the speculators who trade in oil contracts. In theory, these speculators are supposed to provide liquidity to the market thereby enabling it to find true price without distortions introduced by large market participants.
The problem here is that sometimes speculators themselves distort the market. In a bull market, every speculator went long on oil, which distorted market price and ensured that the real price soared well above the price that the oil sheikh needed to purchase his private A-380.
However, the reverse also occured. When the bubble burst, the speculators had leveraged their positions, and now had to sell at any price in order to exit the market. This led to an equally dramatic price drop which has seen oil drop back down to $40 a barrell again.
Of course not all of this is due to the evil speculators. The US Dollar has been appreciating against almost every currency due to a flight to safety. A rising USD means that the Arab Sheikhs (who sell their oil in dollars) can now buy those English Football Clubs cheap. This also tends to drop the prices, and cannot be ignored.
Notes: The data is approximate but the base from which it was taken was the International Energy Agency report of February 2009. Any mistakes and incorrect assumptions are my own however.
Note 2: The strong dollar affects other things than prices of Football Clubs. 
