I had lunch earlier this week with a very clever economist who pointed out that economics really isn’t that hard. To be good at it, he said, you need only understand two things – supply and demand. Once you’ve got those sorted it isn’t that hard to figure the rest out. How odd it is then that when it comes to oil so many strategists and politicians seem to find grasping the supply-demand equation so very difficult. Why for example do they insist on comparing today’s rising oil price with the oil shocks of the 1970s?
Back then the price changes were supply-related. Demand for oil didn’t change that much over the period (except for to fall as high prices hit economic growth) and it certainly didn’t outrun the supply that was potentially available. However, thanks to wars and stroppy suppliers, there were huge supply disruptions. These pushed the price of oil up suddenly and sharply and, as we are constantly reminded by the back to the 70s crowd, caused no end of trouble.
But this time the rising oil price isn’t so much about supply. We may worry about the security of oil supplies, but in truth they really haven’t been much disrupted of late (even the Katrina effect has proved pretty short lived) and right now no one is deliberately withholding oil from anyone else. In fact most OPEC countries are running close to full capacity: even Saudi – whatever it may claim about its production capability – probably has the spigots turned about as far as they can go. Overall supply is flat to slightly rising.
However demand is a different matter altogether: it is rising relentlessly. Demand for oil all over the west is still rising (up 15% in the US between 1994 and 2004 for example) but in the developing world it is soaring. China is the most well known example – note that it has doubled its oil usage over the last decade and now consumes 30% of the world’s oil. But this isn’t just about China: oil consumption is rising fast in India, Vietnam, Thailand, Russia and...