So why *is* the gas price going up?

[jducoeur]

Some time back, I was saying that I expected gas prices to stay lowish for the time being -- that the economy should prevent rises to the level that we saw last summer, at least for a while. That seems like basic supply and demand: demand has softened enormously, so prices *should* remain low. And yet, prices are rising fairly sharply. Why?

As usual, The Economist comes to the rescue: in last week's issue, they have an article largely on this topic. More specifically, it is talking about why we might get another sharp spike in prices sooner than expected.

The article runs a few pages, but the summary seems to be that everyone is anticipating supply problems, possibly serious ones, in the moderately near future. The oil industry is extremely dependent on investment: to maintain production at current levels, they need to keep finding ever-more oil in new places, and that process isn't cheap. (Even if you don't believe peak oil is nigh or passed, it takes real work to find it.) But at the moment, investment has been falling off, for a variety of reasons including the economy. So while current production is well above demand (and may yet cause prices to go down again for a while -- everyone is building stockpiles now, but that can only go so far), in the medium term there is a general nervousness that prices could skyrocket again, because there hasn't been enough investment lately to meet the demands of a more normal economy.

All of which goes to illustrate how the world economy is a *very* complex dynamic system, and there are a lot of feedback loops in it...

Comments

[laurion]

Thanks for this. I had recently been complaining in another forum that prices in the past 2 weeks have risen by 25 cents, and that they've gone up by 50% since the start of the year. The price is annoying, but what bothers me more is the apparent volatility of the price.

[jducoeur]

Well, the volatility isn't entirely surprising. The heart of all economics is the law of supply and demand, which have to more or less balance; the primary mechanism for balancing is price.

When a system is elastic -- that is, it's relatively easy for supply and/or demand to change in response to price signals -- the feedback tends to damp down fluctuations. Demand increases; the price goes up; supply rises in response to the fact that there's more money in it; the price goes back down again. The elasticity prevents prices from swinging too wildly.

However, when the system is inelastic -- that is, supply and demand don't change easily -- prices essentially *have* to move much more sharply to make the economics work. When there is too much demand for the supply, prices can and will rise very quickly until enough pain sets in to either cause demand to slack a bit or supplies to rise. And few systems are quite as inelastic as oil: supply is heavily determined by investments that are made years in advance, and demand is at the root of so much of our economy and habits that we don't readily use less. The result is that price swings can go very non-linear when things get just a bit out of whack, because it often takes massive price swings to force supply and demand to balance again.

So sharp rises and falls in the price of oil don't actually surprise me at all. I just wasn't anticipating it *now*, because I wasn't taking some of the factors into account.

(All of the above is greatly over-simplified, of course...)

[corwyn-ap.livejournal.com]

I once asked Patri (the younger), who was disputing peak oil, what would be the signs that we had reached peak oil. Extreme price volatility was one sign he mentioned.

Consider that the time to re-purpose an oil refinery is over a year.