Outlook: What's the right price for oil?

Jul 05, 2011

In his recent Outlook piece, "The unpredictable forces behind oil prices," Post energy reporter Steven Mufson explained the forces behind the oil market chaos. He will be online Tuesday July 5, at noon ET to discuss his piece, answer your questions about oil prices and more.

Have a question? Ask now.

Thanks for joining me today. I am a reporter in the Post's financial section and I've been covering energy for the past four years. I also wrote about the oil and gas industry for The Wall Street Journal in the early 1980s. I'll do my best to answer your questions, but advance warning that there is a lot of uncertainty and debate about what makes energy prices move and by how much.

What role do you think speculation plays in price swings and over all cost of oil futures?

Speculation is a loaded word, I think. But what is an important factor, I think is that a lot of non-commercial, financial players have gotten into the oil trading business. From what I've read by economists, the net flow of their money influences the price. So from 2005 to 2008, when billions and billions of dollars moved into oil investments, that probably helped drive prices up higher, or maybe faster, than they would have gone otherwise. Over time, however, prices will be governed by supply and demand.

My view is that the right price for oil is whatever the market demands, and people will pay. America and the other nations subsidize world prices for oil via military guardianship of oil producers, oil fields, shipping lanes and choke points (Strait of Hormuz for one). If those "defense" costs were factored in, oil and refined products would be a good deal higher than they are. The Iraq war could be argued to be a subsidy cost, or at least partially so. We certainly wouldn't be so interested in the Middle East was it not for the world oil supply that those countries contribute to. While we get most of our oil from other sources than the Middle East, the prices we pay are linked to overall world prices. My back of napkin calculation suggests that adding $1.00 a gallon to the going price for gasoline, and perhaps as much as $1.50 more, are reasonable. This would drive Americans to rage to realize and pay actual oil and gasoline costs, but it is what it is.

You make very good points. It's one that a lot of leading military officers and members of Congress make. I think it was Sen. Lugar who once estimated that we must spend about $50 billion a year safeguarding oil areas. One way of looking at it would also be to say that our extra defense burden has contributed to the budget deficit and national debt.

It appears the Mid East Oil producers have the world by it's short hair, and their greed increases with each barrell of oil sold. How can the world convince this group to do the right thing and bring their asking price down to where it should be. What should the price of their oil be? I say no more than 55 dollars per barrell.

Part of what I was trying to say in the article is that it is hard to say what the price of oil "should" be. As a practical matter, Mid East producers are going to do what they feel is in their national interests. For most of the past three years, the Saudi oil minister has said that meant prices around $70 a barrel, and that seemed high when he said it. But here we are at higher levels.

..post the link to his Outlook piece? Thanks. Finest kind..

What should gas cost?, The Washington Post, July 1, 2011

Whenever the price of oil drops, some market analysts treat it as a bad thing. Why do you think that is? I'm inclined to think that this is bad for a few wealthy investors but good for everyone else, since oil prices affect the costs of so many goods.

Market analysts often do exactly what you say. Lower oil prices is usually bad for the big integrated oil company stocks, even if it's good for consumers. One other dimension -- not what the market analysts are thinking about -- is the environmental one. Higher prices discourage consumption and people worried about climate change prefer lower consumption. President Obama has chosen to mandate higher fuel efficiency instead of raising taxes to lower consumption.

Is economic growth in China and India inexorably going to lead to rises in the price of oil? The book ""$20 per gallon" some time ago analyzed the major changes in our society that will be caused by such increases, but other analysts seem to think we will always find new sources of oil or new kinds of energy as substitutes.

So far, new discoveries have defied predictions about the world running out of oil. And $20 a gallon strikes me as excessively alarmist. But China and India will consume much more in the next few years than earlier as people's living standards rise and as the number of cars in each of those countries inexorably rises. And, despite the sharp fluctuations in price and the drop below $40 a barrel in late 2008, it seems to me that prices are fluctuating around a higher level than before. The world economy was very weak in 2009, yet the average price for crude oil (nominal price, granted) was higher than any year prior to 2006 or 2007.

How would the price of oil be effected if speculators were excluded by requiring them to take delivery of the oil?

I'm not sure, but I think that it would be difficult. It would certainly change the character of the futures exchanges. Generally economists believe that having more trading volume produces a more accurate price.

Why do we let oil companys do as they please and cause other goods to increase in price! Why can't the U S put restraints on how for they can go!

We tried oil price controls -- along with wage and price controls -- back in the 1970s and that didn't work out too well. Remember gasoline lines?

Aren't the funds responsible for the hike in price? Consumption is on the decline you to recession around the world.

Consumption declined less than you'd think. Remember that China and India have been growing rapidly, even though oil consumption in the U.S. and the rest of the OECD countries is pretty flat or slowly declining. And here in the U.S. consumption didn't drop as sharply as it did after the 1979 oil price spike. Back then, a lot of utilities were still using oil and they switched to coal or natural gas. Consumption dropped a lot. But now, it's hard to get such a quick sharp drop in consumption here in the U.S.

Given the number of direct subsidies, tax breaks, and incentives to the petroleum industry - what is the "hidden" taxpayer burden (excluding sales, use, and excise taxes) that we all pay as a premium on each barrel of petroleum (domestic & imported)?

Good question and I haven't done that calculation. Just doing a back of the envelope one now though it would go like this: using Obama budget numbers all oil tax breaks (or incentives) come to $4 billion a year and we consumer 20 million barrels a day or so, or about 7.3 billion barrels a year. That works out to about 55 cents a barrel, or about 1.3 cents a gallon. Not a tremendous amount.

I would like to question the underlying assumptions of our existant "Energy Independence" Policies. As energy is a fungible commodity, is it not worth consideration to encourage imported crude as opposed to inefficient resource management. Why is global competition encouraged in all sectors except energy?

I think energy is a bit different because of the national security dimension. I suppose you could make that argument about some other resources we import, but past oil shortages have really choked the economy in a unique way.

Do you think "peak oil" economists are correct when they say oil is likely to go to $200 a barrel by 2012 because the oil that is relatively easy and cheap to extract and refine is nearly gone? And that while the world is not going to run out of oil, we are running out of the oil we can afford to burn? Thanks.

I wouldn't venture to make a price prediction of any kind. I can't help saying, though, that it's hard to imagine $200 oil, at least that soon. I think that a big drop in consumption would undercut prices that high. There is a peak out there somewhere, but so far luck and technology has helped keep world oil production growing and growing at costs we're willing to pay. It just might not be rising as fast as we'd like.

Excellent article. I don't know why there isn't more journalism about a topic that creates so much water-cooler talk. Random comments for your reply, if desired: 1. In 1998, gasoline cost about $1/gal, a price that had been pretty constant for almost 20 years, except when Mid East war drove it up or down. That's also when the oil companies started merging, and the price started rising. I can't believe it's a coincidence when the number of major actors in the wholesale market contracts like that. 2. The price of oil will plummet once we have the option of NOT BUYING IT. A coal-based synfuel would establish a ceiling for gasoline prices. 3. There's an Exchange Traded Fund (ETF) abbreviated USO that tracks the wholesale price of petroleum. It can be purchased in any amount, and could be used by individuals to hedge their personal consumption, if bought when gas is cheap to be sold when prices are high.

Thanks for your note. The 1998 price was unusually low. At the time, some people thought it would last forever and the days of oil shortages were over. But it turned out to be a great time for big oil companies to "drill on Wall Street" as the saying goes, buying up other companies and their reserves at cheap prices. Smart moves from a corporate point of view, even though the money used in those acquisitions did not increase the amount of oil exploration.

Re other question: President Carter backed a synfuels program and it did not do well. Cost issues, water issues, other environmental issues. If we are going to have a non-oil choice for fuel someday, it seems to me more likely that it would be a biofuel.

How much do you think the oil shale developments will impact oil supplies and prices? Will it be the same as the gas shale oversupply?

Good question. From what I can gather, so far the amount of oil from shale is significant in terms of stabilizing U.S. oil production for a while. But it is nowhere near the vast, game-changing resource that most people believe gas-from-shale will be.

the drop in oil prices seems to be meeting resistance around $95 per barrel, what does that relate to per gallon at the pump? Why do prices go up fast and come down slowly, if at all? Thanks, you do a good job for the Post.

There are 42 gallons in a barrel. So $95 a barrel crude oil means $2.26 a gallon in raw material costs. (There is some variation depending on the quality of crude oil.)

Then you have refining, distribution, marketing costs and profits on top of that.

Prices go up quickly because refiners, wholesalers and retailers want to be able to raise prices to cover costs, and they go down slowly because refiners, wholesalers and retailers want to hang onto large profit margins as long as possible even if costs are dropping.

Phase out subsidies to spur innovation and R&D in sustainable energy sources. Whenever the price spiked and hits consumer wallets we get positive changes in behavior but then it reverts back to normal once things stabilize. Given this oil is a limited resource - there's clearly a need to invest in alternate sources, increase efficiency and eliminate green house gases. Why not, over time, make consumers pay the try cost of fuel?

Thanks for this question. Americans' memories are very short. Just look at last month's list of best selling cars. The logical policy move from an economic point of view would be to tax gasoline and raise prices substantially and use that tax revenue to either slash the deficit or (if you're a Republican) refund it to people who would be hurt most by higher gasoline prices. But that course of action is generally considered political suicide and there is no sign that we will do that.

Given the lock that OPEC has on the market, would increased US production have any effect on the price of oil at all?

Yes, though it is unlikely that U.S. production will increase by much. Just holding U.S. production steady as older fields decline would be an accomplishment.

I don't know why the peak oil scare has any credence. As the price of oil goes up, so too does the amount of "recoverable" oil. Canadian tar sands are a great example. If prices keep going up then we'll gasify and upgrade coal. We won't ever run out of hydrocarbons to burn. What we should be worried about is burning so much that we make the planet uninhabitable.

Thanks for this comment.

Global oil consumption in 2010 was higher than in any previous year, even 2007 (the old record). Global oil consumption has increased by more than it fell following the latest recession. Since oil is a global market, it is the world's consumption that matters, not just here in the United States.

This is absolutely right. So there are a lot of factors going into price too, most of them beyond our control. But the United States is still the largest consumer of oil in the world so what we do matters.

Is there a way individual consumers can "hedge" the price of fuel, the way the airlines do?

Not that I know of.

Say you're interested in buying a house, and you think that prices are going to go up in the future. Wouldn't you want to buy now? But the actual supply of houses isn't changing, so is this speculation? Say you're the seller (think Mideast oil producers in this analogy) of a house. Prices are going up, so you price your house a little higher than the going rate. To your surprise, you get a bid higher than your asking price (because someone really wants your house - increased demand). Are you going to sell at your original price or sell at the market rate (being defined as the price someone is willing to pay)? As you clearly say, arguing over the "fair" price of oil is a little ridiculous. The price will be whatever buyers and sellers agree to.

Right. In a truly speculative market, you would get growing stockpiles, or inventories, of houses or oil or whatever. So in the housing bubble, you had people buying extra houses figuring they'd be able to sell them at higher prices later. Oil inventories have been relatively high for the past couple of years, but some people argue that we haven't seen an inventory buildup high enough to say that this oil price is a bubble price like housing prices were. Some people argue that the futures exchange prices for more distant delivery dates are important to examine for signs of people's expectations or of what Greenspan might have called irrational exuberance.

I understand the argument that if an oil company pays $95 for a barrel of oil, it will probably charge a given price for gas. My issue with this kind of talk is that it suits the length of a TV news segment but is a bit simplified. The $95 price is just one index of a minority of the sales that make up the global oil market. I understand that big refiners are not buying their oil at that price - they negotiate deals with the House of Saud or whomever and good luck ever learning the terms of those transactions. Also, if Exxon has lifting costs of $40 (pumping oil from their own fields) but sells gasoline as if they paid $95, then they might earn more money than any company in history. Wait, that already happened.

If Exxon has (and Exxon does have) lifting costs much lower than prevailing crude prices, you see that in the company's profits for "upstream" activities. Those have been very very high. But Exxon buys additional oil for its refineries. For that they pay an oil exporting country. They don't necessarily pay $95 or whatever the benchmark is. They negotiate quality differentials, or discounts and premiums, depending on the quality of oil. Those differentials vary depending on the market. So the Saudis might, for example, discount more sharply its Arab Medium from its Arab Light grades and that might help some integrated companies like Exxon or refining companies.

Thanks for all the questions. I'm sorry I didn't get to everyone. And thanks again for reading the Washington Post.

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Steven Mufson
Steven Mufson is a reporter on the national staff of The Washington Post and has served as Beijng bureau chief for the Post.
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