First, the logical fallacy. The reason for the spike in prices was that world industrial capacity was running at full throttle. At the exact same time, global crude extraction had hit a plateau. Ever since about 2005 supply has hovered at about 86 million barrels per day (MBD). The fluctuation in price, between about $50 to $80+ in the period 2005 to 2007, should have brought forth more supply, if there existed any buffer capacity. It did not. Two visits in rapid succession by George Bush to Saudi Arabia this year and fervent pleas to raise output did not help. The Saudi monarch pleaded helplessness in return.  

Saudi Arabia was the swing producer until now, meaning it would vary output to maintain stable oil prices. That they could do little is a clear indicator that supply was at its peak. Demand on the other hand was going full steam ahead. This led to rapid rises in prices. Needless to say, speculative hot money played a big role in driving oil prices further up as consistently rising prices of any financial security, commodity or asset always create a bubble especially if ample, return-hungry, liquidity is sloshing around the global marketplace.

This same inelasticity of oil led to a plunge in oil prices, quicker than its meteoric rise. Oil adds utility to all other natural resources — utility of form, place, and time. When economies around the globe began to slow down house prices began their descent to rational levels, stockmarkets crashed, banks collapsed, stores closed, manufacturing tanked, unemployment began to soar, wealth evaporated. As a result of the above, aggregate demand plunged. When folks do not have money to buy products, frivolous or otherwise, the demand for energy and hence crude oil, which converts natural resources into marketable products, will also naturally plunge. Hence, crude oil prices dived. 

To mistake this temporary dive in crude prices as permanent and react by lowering crude distillate prices is short-sighted, to say the least.

Add to this the fact that the IEA has reported in its 2008 Annual Report that the world’s biggest oil fields are declining at a rate of 9 per cent annually. Keep in mind that in 2007, the 20 largest oilfields provided 27 per cent, 19 MBD of global conventional crude. What this implies is that, the 86-MBD supply that we have recently seen is set to go down, as new sources of supply cannot make up this decline in sufficient measure. The absolute kicker in this story is that we don’t know when demand will match supply again. We will only know once we are there, via another explosive rise in oil prices.  

By lowering prices today policymakers have told economic agents: go forth and make merry. We know where this attitude has landed us. Rather, the message that is required in these times, when we are at a plateau in oil extraction and are henceforth going to see only declines, should be one of conservation and energy efficiency. Governments can gather surpluses during such times of low crude prices and high crude derivative prices and use them for better creating and targeting safety nets for the vulnerable. 

The second issue, the one of the myth that this lowering of prices is in the interest of the common man will show itself for what it is when economic agents have to face rising crude prices again. If educational and informational campaigns are conducted right, economic agents will see the rationale for high prices and can better engineer production and other systems so that they can face the onslaught of the coming higher prices.  

A floor for crude derivatives’ prices is a must. By alternately raising and lowering prices for energy, agents do not get proper signals and stimuli upon which to shape their economic and social lives. The ones who get hurt the most in this vicious oscillating game are the most vulnerable sections of society. It is sinister to perpetuate a myth in their name. 

Judging from their public pronouncements and actions, almost no policy-maker, whether of the executive or legislative branch, seems to be aware of the deep relationship between energy quantum availability, their relative and absolute prices and economic, social and political development. Few have put it better than Stuart Kauffman: “Life is a vast Monopoly game, with energy the ultimate currency, and the sun our banker of last resort.” Central bankers would do well to heed that reality while they attempt to boost economies, following in the footsteps of Greenspan and his cohorts. 

The writer is a Hyderabad-based economist and oil watcher

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