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The Real Price of Oil

Discussions about the economic and financial ramifications of PEAK OIL

The Real Price of Oil

Unread postby DOR » Tue 31 Aug 2004, 03:57:35

The Real Price of Oil (my way of saying "Hello" !):
--> R.Heinberg
--> A.M.Bakhtiari
--> ?D.Pfeiffer?
____________________________

The Real Price of Oil

Every time the price of oil hits a new high (futures are trading at US$45 a barrel [bbl] at this writing), someone points out that the black gold is still cheap “in real terms”, i.e., adjusted for inflation. The calculation is based on the amount of inflation between some reference point in the past – usually May 1980, when nominal prices for West Texas Intermediate (a benchmark) neared $40/bbl – and today.

Nearly 25 years ago, the politically driven price was compounded by a policy decision some eight months later, when the US government decided to remove price and allocation controls on the oil industry. As smaller players dropped out of the market (45 percent of US refineries closed in 1981-85), crude oil distillation capacity dropped by 16 percent and imports more than doubled. Predictably, prices soared.

Prices, then and now
Fast forward a dozen years, to 1993 and the aftermath of the First Iraq War, and set a new benchmark. Since 1993, the nominal US dollar price of oil doubled, from $18.5/bbl to this year’s average $37/bbl. During that time, the Japanese yen rose 2.4 percent against the dollar (albeit, not steadily) while the Korean Won fell 31.5 percent and the Thai Baht 36.1 percent. Although we like to think of our own Hong Kong Dollar as pegged to the greenback, in fact it depreciated by 0.7 percent over more than a decade.

When a currency loses value against the US dollar, oil becomes all the more expensive in local terms. Today, Thailand is paying 216 percent more, in Baht terms, for a barrel of oil than it did in 1993. Koreans pay 194.9 percent more, and the Japanese an additional 97.3 percent over the price in Yen terms 11 years ago. Our own costs are 103.5 percent higher, in line with the benchmark dollar price’s 102.1 percent rise.

However, other prices in each of these economies have moved as well, which means that goods and services that require oil as an input (delivery trucks, plastics manufacturing, electric lighting, lubrication, etc.) should be charging more for what they sell, and thus off-setting some of the increased price of oil. In the US, cumulative inflation since 1993 was 23.1 percent, far below Korea’s 60.6 percent or Thailand’s 35.4 percent. Prices in Japan and Hong Kong fell, by a cumulative 0.9 percent and 0.1 percent, respectively.

Putting the two together, we come up with a real price of oil in local currencies. Our base is the US dollar, not only because it is the dominant currency in the world but also because oil is priced in dollars. In America, that price is 64.2 percent higher in real terms than in 1993. What is surprising is how the other economies fared.

In Thailand, a barrel of oil in real terms now costs 133.5 percent more than in 1993, significantly above Japan’s 117.5 percent higher price paid. Deflation hit Hong Kong companies’ ability to raise prices to off-set the higher cost of energy-related inputs, which means we now pay 105.3 percent more. Korea comes off best, as domestic inflation – allowing sellers to raise their prices – did go some way to balancing out the depreciated currency. Koreans now pay 83.6 percent more, in line with the 64.2 percent real rise that needs to be accommodated in the US.

The impact
Many of the rich countries are less energy vulnerable than in the past, because – like Hong Kong – their economies have graduated from manufacturing to services, and particularly to information technology.

The utilities sector is clearly the biggest user of oil, and where prices are regulated can be badly hurt by rising prices. Jet fuel costs certainly hit airlines’ profits, as does the higher price of petrochemical fertilizers hurt farmers. The chemicals industry uses hydrocarbons as a feedstock, and the aluminum smelting business is always electricity hungry. Add one to the other, and throw in higher utilities bills all around and the automotive sector gets hurt worse than most.

Higher energy costs hit consumers in more ways than one, and from there move on to deliver another blow to manufacturers, retailers and services. As families spend a larger share of their incomes on petrol or power, less is available for other purchases. Moreover, the energy input cost of the various things families buy rises in price, further curbing their discretionary spending. (This can cause some confusion among monetary policymakers. Rising prices would suggest increasing interest rates, but falling demand makes that alternative less attractive.)

Over time, economies adjust to new prices levels. In the 1970s and early 1980s, more fuel efficient automobiles were developed and rapidly sold. In the 1990s, cheap petrol helped stimulate demand for SUVs. At the end of the day, government policy cannot really do much to ameliorate the effects of a short-term energy price shock. In the longer term, however, energy efficiency regulations help economies prepare for future uncertainties.

---DOR, Aug 31, 2004, Hong Kong
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