The oil zombie

Posted on Nov 18 2011

Ed Stephens Jr.

 By Ed Stephens Jr.
Special to the Saipan Tribune

I hate it when the real world intrudes on my happy little bubble, but I just got a couple of calls about oil prices. That’s always something to heed given that fuel is a giant chunk of family budgets in the Commonwealth. So, let’s see what this story is all about.

Ah, here we go: West Texas Intermediate (WTI) oil climbed through the $100 mark yesterday, a five-month high. When things hit a round-number gig like that, everybody starts yakking about it, and then they call their friends, who in turn also start yakking about it, and so on.

Oil is like a zombie. Just when you think you can turn your back on it, the spooky music starts playing and it jumps at you again. As of yesterday WTI stood at $102.59 a barrel, up $3.22, or 3.2 percent, for the day.

That puts it up about 25 percent from one year ago. However, earlier this year prices were also above the $100 mark, so it remains to be seen if we’re dealing with a trend here or just mere fluctuations.

On related fronts things were pretty tame yesterday. Brent crude, another important benchmark, actually fell in price by $1.48 a barrel.

I took a look at unleaded gasoline futures for December, and they were up 4 cents a gallon, or 1.6 percent.

Overall, I think the little spike in WTI isn’t a reason to worry about things. And taking a silver lining approach, it’s a good excuse to look at the situation now, the better to have our heads around the gig in case oil really does start climbing again. So let’s get out the beach chairs and get economic about stuff.

OK, first order of inquiry: Why all the jumpy people? Maybe because when oil prices make headlines, everyone reflectively worries about the wacky situation in the Middle East. After all, the war of words with Iran seems to be on the upswing again. The worries, of course, are that the Persian Gulf oil shipping lanes might get walloped if things take a turn for the nasty.

The tongues, they are a wagging on this note. I read one recent estimate that Iran on a war footing could shut down the Gulf for anywhere from one week to a few months.

Well, any which way, weeks, months, today, tomorrow, next month, next year, never, whatever, whenever, Old Elvis, Young Elvis, I doubt anyone can price this risk accurately. I’m sure it’s a large component of oil prices, maybe even the largest. That sounds a little weird, but the fact is that commodity prices are not driven by today’s reality, but are driven by expectations about what will happen in the future.

In other words, the time line points backwards: Today’s price does not drive the future price, but, instead, the future price drives today’s price, and that future price is largely built on risk.

In a world with no uncertainty, this wouldn’t be the case. Indeed, in a certain world we could merely take the current price of a commodity, add some factors for storage costs and interest rates, and thus derive the future price. A trained monkey could do it.

But the real world is full of uncertainty, which is to say, risk, thus inspiring buyers and sellers of commodities to trade forward and lock into prices in order to avoid risk. The people who buy that risk are, of course, pricing their activity based on just that: risk. Anyway, that’s why these prices flow from the future back to the present instead of the other way around.

It’s logical, but probably not intuitive.

Outside of the war risk thing, I don’t see much reason to expect oil prices to climb right away, but the world is a complicated place, so what I see isn’t much of the picture. But I do wonder, smugly ensconced in my beach chair, just who is going to buy all that expensive oil? Americans and Europeans are going to be too broke to drive cars once their Ha-Ha debt gets laughed off the planet Earth. The Chinese? They’re the ones holding the Ha-Ha debt. And, furthermore, they’ve probably got other problems to contend with next year. India? Brazil? Well, pick your country, pick your oil demand, and place your bets.

My bet is that I’m not making any bets, not on this, not now. I think there’s a lot of risk coming up in 2012, and there are so many cross-currents that I’ve got no idea how things are going to come out in the wash.

Bottom line: The oil zombie might be stirring but he’s not awake again, so yesterday’s action might drive gas prices up by only a few cents, if that. However, the trend has been up for the past few months, so I’ll keep listening for the spooky music just in case.

Visit Ed Stephens Jr. at Ed is a pilot, economist, and writer. He holds a degree in economics from UCLA and is a former U.S. naval officer. His column runs every Friday.

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