Pricing oil; the highs and the lows

Pricing oil; the highs and the lows image

Text: Tito F. Hermoso / Photos: Brent Co | posted February 02, 2015 10:00

Without a doubt, cheaper oil is consumer cause for joy


Without a doubt, cheaper oil is consumer cause for joy. It follows, since we can hardly do or have anything in this world that isn't directly affected by the abundance [or scarcity] of oil. Economists have convinced the public to characterize times of cheap oil as boom times and expensive oil as bust. But are things really as simple as that? As in all things, nothing lasts forever, there is always a cost to this and cheap oil is not always the economic advantage as it seems.

Pitch beginnings

At the dawn of history, no one would have worried or cared for the price of oil. Oil or petroleum and its many cousins like bitumen, pitch, tar, coal and natural gas, were only as useful as their availability around the immediate vicinity. Ancient Babylon's streets were paved with pitch, which oozed out of nearby tar pits. Pitch was abundant in the areas surrounding ancient Imperial Rome so much so that the cruel Emperor Nero made liberal use of such applied to crucified Christians as a sadistic form of street lighting. Otherwise, civilization burned oil for cooking, keeping warm and illumination.

Oil becomes a commodity

During the early days of the Industrial revolution, steam engines and steamships burned coal, oil's more easily mined and more portable cousin, to power transportation. It was only when science discovered technology to drill oil out of the ground did the search for oil fields begin in earnest. Hence the discovery of oil reserves in the Middle East, the Dutch East Indies, parts of the USA and Africa. The steady rise of oil as the fuel to produce electricity and to power the multiplying automobile's internal combustion engine induced the modern world's dependence on it. Wars were fought and economies rose and fell because of oil. The US oil embargo on Japan triggered World War 2 in the Pacific. The Suez Canal War of 1956 produced the world's first global oil crisis, followed by the Yom Kippur War of 1973 and the Iran-Iraq war of 1979. After those oil shortage shocks, the world was to experience a reversal of fortune with the oil glut that followed after the unification of Germany and the first Iraq war in 1991.

Oil price chart

Recent crisis

The combined effects of the collapse of Lehman Brothers in 2008 that triggered the Financial crisis of 2009, the voracious energy needs of a rapidly growing Chinese economy and the 2010 uprising against decades old entrenched regimes of the Middle East oil producing countries added to the upward pressure to prices that hit a record USD 100.00/barrel. Today, a slowing China, competing over production between pirate non-OPEC sources and OPEC sources have already caused prices to dip below the benchmark USD 50.00/barrel of 2009.

In focus

A quick flashback at recent history: shortly after that steep climb in oil prices, the market stabilized at USD100.00/barrel until technology made two discoveries 1.] "fracking" or the process of using steam pressure to extract oil from peat bogs, tar sands and shale was refined for mass exploration 2.] modern drilling techniques that allow drilling from a diagonal angle 3.] hight tech geological surveys that discover oil reserves deep under the ocean floor. Hence the USD100.00/barrel price made investment in more efficient extraction technology worth the risk. It was a risk well worth it because with the new technology, oil reserves that were difficult to extract are now part of the world's expanded oil reserve.

When threats work

Thus, there are some good effects from the threat of rising oil prices. There's the push for technology to maximize existing oil reserves and discover new, quick and easy ways of extracting oil and storing it for quick access at lower expense. Rising oil prices push car makers to make cars more economical. It drives drivers to make better use of their fuel by driving more efficiently and by driving less. It pushes power producers to explore other forms of petroleum - natural gas or coal - or other forms of energy - nuclear, hydro, etc. -to fuel their power plants. It justifies exploration into hydrogen and fuel cell, as well as solar, wind and wave energy generation. It drives factories, refrigeration, heating and storage to be more efficient. It explores existing applications of recent forms of illumination - laser, LED, HID, etc. - for a more efficient substitute. We have high oil prices to thank for our more acute and widespread awareness of the environment, inducing us to better conservation and production methods. And ironically, it is because of our sensible reaction to rising oil prices, that we have lower oil prices now.

Back to the good 'ol days?

Living in an era of lower oil prices should also serve us a warning for us not to be complacent. We shouldn't go back to the bad old days when oil was so cheap that we took it for granted. We didn't care about insulating our homes and our offices. We didn't care if we preferred to take the thirsty V-8 to short hops to the grocery to buy a packet of crisps. We didn't care if all that useless junk in the trunk or if under-inflated tires penalized our consumption by as much as 5.0%. We didn't care to push our government to expand mass transit options even as we suffered the massive traffic caused by too many private cars on so few roads. Yes, lower oil prices did put downward pressure on the cost of living, and that is always welcome, but we also have to live smarter with an eye on the future.

Doomed to cycle?

But are we doomed to fall into this cycle of rising and falling oil prices? A few truths we must remember. For every action there is an opposite and equal reaction. This applies to what motivates our consumption and conservation during times of rising or falling prices. The Law of Supply and Demand: prices go up in times of scarcity and down in times of abundance. In our modern world of financial hedging, any hint or assumption of impending scarcity/abundance already triggers price movements. Having this in mind, we now should remember the relief or anxiety we feel about fuel prices is dependent on how we foresee the immediate future so we all have a stake in trying to control it to iron our the extreme bumps. Remember also, that how we foresee the future is stimulated by current shocks that upset the status quo.

Inflation can be good

We've grown to condemn inflation- steady increases in prices of everything, whether if it was triggered by an oil shock or financial crisis - as it raises the cost of living. But we've also experienced the opposite - deflation or a steady decrease in prices of everything. The danger in a deflation cycle is the decreasing value of money, contrary to its function as a store of value. Consequences are that businesses will cease making money and hence, stop investing, hiring workers and consumption, which would lead to a slow down and an eventually halt in producing for any kind of economic activity.

An ideal world

In an ideal world, Economists would prefer and businessmen would jump for joy, if prices oil and all other commodities dependent on it - were stable. They can only be made stable if the world would be unified and quick to dampen uncontrolled and sudden swings - whether upward or downward - in prices. But then what the right price is, or the right production level for the right supply to meet the demand is as varied as there are opinions. Even with the recent changes in Saudi royalty, OPEC is currently committed to regain control of world pricing. It will keep its high production quotas, hence pushing prices lower in order to drive the non-OPEC producers out of business. This current price war still has some ways to go before some other crisis stimulates a another movement, whether it be a return to balance or not. As a consumer, the public and the government should take advantage of it. A prime example of this is Indonesia. For years, Indonesia, like Iran and Venezuela have addicted their public to government subsidized cheap fuel, which not only bankrupts their central bank but also allows the export black market to thrive. But in this recent oil glut, Indonesia's Jokowi government, in contrast to all the previous governments, took the daring step of canceling the fuel subsidy to the benefit of widespread investor approval.

To be prudent

We are not an oil exporting country, so during the 2008-2009 financial crisis, the government froze fuel taxes in order not to push the economy into an inflationary spiral of rising prices. Now that oil prices have come down, perhaps it is time for the government to resume taxing fuel, this time with a more environmental and selective focus - low taxes for Euro 4 or Euro 6 fuels and higher taxes for Euro 2 fuels. That way, the government can reduce pollutants and replenish the national treasury while pump prices remain stable and affordable.