What´s going on with Oil prices?

What is your first impression when you look at this graph (taken from Wikipedia)?

Something is really going on, right? This is clearly not just ´noise´, or market volatility (up today, down tomorrow, but something is clearly driving a trend in the price of oil in here. What can it be?

Well, if according to my rudimentary understanding of economics, when prices shoot up like that, it can be due to two causes:

a) Especulation on the part of investors.

b) Change in the supply-demand relation (large increase in demand and/or drop in supply).

A mix of these two causes explains pretty much any sudden increase in prices: Whale oil in the late 19th century, internet stocks ten years ago, Spanish real state market over the last 20 years, etc... But how about now? Could it be that especulation is not the main driver? In such a case, why is supply not keeping up with demand (as it did until 2003-2004, apparently, according to the graph) ?

By now, you probably suspect that today´s post is about Peak Oil. If you think this is some bad translation of a mountain´s name in Northern Spain, then you really, really need to check out this documentary:

http://www.imdb.com/title/tt0776794/

In very basic terms, Peak Oil is the point in time in which globally we reach the maximum extraction rate of crude oil. Perhaps somewhat unintuitively, it coincides with the point at which around half of the available crude oil reserves have been extracted. It does not mean that there is no more oil in the ground, and it does not mean that we´ve run out of oil, but it does mean that once past Peak Oil, tomorrow there will be less oil produced than today (or only the same, in the best case). The main thing is, this is not just a crazy theory from some wackos in a compound in Texas, but it actually originates from within the oil industry itself! As I will explore eventually in this blog, whenever it happens - there´s quite a bit of uncertainty in the date - it will drive a change of global proportions, in the same order as Global Warming, but with a much shorter fuse.

The consequences of this simple fact -undisputable as it that will happen at some point, the only question being ´When´ - its consequences are massive, and I must admit that I was caught quite unaware of all the potential ramifications. The most obvious impact is that, once past Peak Oil, global oil consumption cannot grow anymore, and in fact it is forced to reduce itself as a consequence of the daily reduction of extracted crude. This in itself sounds already quite serious, but just image the way in which global demand for oil may be forced to go down... Voluntary reduction in consumption? Not bloody likely. Poor people being priced out of buying more gas? Possibly. Major recession destroying industrial capacity, and thus demand? Well, you can see the scenarios are multiple and they can be mixed & matched in any possible combination, but none of them is encouraging. In the end, reaching Peak Oil basically means the end of economic expansion, at least globally, and the end of the classical Bussiness Cycle. What then? This is the question I´ve been struggling with for the past couple of weeks. I do not have an answer yet, but I will be posting my thoughts on this topic, until I exhaust everybody´s interest, or until the lights go out and I have to pick up my bow, Mad-Max style, to hunt some rabbits to feed my family.

For those interested in starting with a little more info on this issue, as usual wikipedia offers the best all-around primer on Peak Oil:

http://en.wikipedia.org/wiki/Peak_oil

And this just in: Matt Simmons, an oil industry expert whom I´ll be referencing more in my next posts, was interviewed today in Bloomberg TV and had nothing but rosy pictures and good news for everybody!