Tuesday, October 30, 2007

The Oil Debate

We had a dynamite oil discussion on last night’s Kudlow & Company. My take on the price of oil is that it’s largely being determined by the strength of the global economic boom. It’s about the global spread of capitalism throughout China, India, Eastern Europe, and everyplace else.

Incidentally, higher priced oil doesn’t pack the same punch as it used to.

Check out the following chart.

Isn't that wonderful? What it shows is that the use of oil per GDP unit is down 50 percent since World War II. Around 1950, energy consumption was just under 20 percent. Then around 1980, it had fallen to around 15 percent. Nowadays, it’s down under 9 percent. This is good news. So why’s everyone hyperventilating about oil? Why’s everyone so pessimistic?

Here are some additional thoughts from a couple of my guests.

DAN YERGIN (chairman of Cambridge Energy Research Associates): [The price of oil] is decoupled from the fundamentals of supply and demand. What’s driving the oil price now is the cauldron of geopolitics, momentum and financial markets, and tying it all together, fear, combined with a weakening dollar. So we could be one or two events away from $100 a barrel oil. So events could put it there. But if you look at it in terms of supply and demand, it’s not as connected as it was in the past…I think the way it’s going now, some other events, some more intensification—we’re just six dollars away from $100, we can get there. But you know…economics work. And at some point, the price will respond to it, particularly when it’s disconnected from fundamentals.

BOB HORMATS (Vice Chairman of Goldman Sachs International): I think [the price of oil] is out of line with the fundamentals, let me address that first. Oil is not just an economic commodity, it’s a political commodity. And every time you get a lot of fear in a region that produces a lot of oil, even if it’s not directly related to that oil supply, even if it’s around that area, it does tend to push prices up. And we shouldn’t forget the fact that there’s an increasing escalation of pressure on Iran. That doesn’t mean the [United States] is going to move against Iran, but the markets look at this and they don’t want to get caught flat-footed if in fact that were to occur. I don’t think either of those things are going to happen in the near-term. I do think that the price is out of line with fundamentals. But as long as these political risks are perceived in the market, [the price of oil] is going to be high…I think the next move is going to be up because there are so many political uncertainties in the oil producing parts of the world. It’s hard to see it going down. Economically, it would go down, but the geopolitics of oil are going to keep it up higher.