What’s really driving up oil prices?

Behind the Rising Price of Oil

Ismael Hossein-zadeh

[Published in the Des Moines Register (November 17, 2007), Op-Ed page.]

The price of oil is fast approaching the threshold of $100 a barrel. But one hundred is simply another number. And if the neoconservative forces in and around the Bush administration continue their saber rattling against Iran, oil will soon be priced at much higher than $100 per barrel. The fear of a military clash with Iran interrupting the flow of oil from the Persian Gulf is the major force behind the dramatic rise in the price of oil.

Many observers tend to attribute the skyrocketing oil prices to an alleged discrepancy between supply and demand in global markets, postulating that the fast growing energy consumption by countries like China and India is exceeding production, thereby putting upward pressure on price.

A closer examination of the oil facts and figures reveals, however, that there is in fact an overall parity between supply and demand on a global level. This is largely because the increased energy consumption by countries like China and India is greatly offset by the fact that, having learned from the past oil crises, advanced industrial countries such as the U.S., Europe and Japan have increased energy efficiency in the past quarter century or so.

For example, in 1981, the United States devoted nearly 14 percent of its overall gross domestic product to energy, according to the Energy Information Administration. By 2006 that number had fallen to about 9 percent. Cars, airplanes and other means of transportation have become more fuel-efficient than ever before. Both businesses and consumers are also doing a better job of trimming their energy costs.

The weakening U.S. dollar is another contributing factor to the rising price of oil. Since oil is priced in terms of the dollar, oil exporters will therefore ask for more of the cheaper dollars for the same barrel of oil.

But the weakening dollar is also largely due to the raging war in the Middle East, the escalating military spending, and the accumulating U.S. national debt, which recently surpassed nine trillion dollars. As in the case of an individual or a business, the higher the indebtedness of a country the lower its creditworthiness and the cheaper its currency.

The danger here is not simply a weak or weakened dollar. More importantly, it is a weakening dollar rolling down a slippery slope: the depreciating dollar is bound to prompt dollar holders to dump their dollars and switch to alternative sources of preserving their assets.

This explains why, for example, a Chinese lawmaker recently suggested that the country should convert part of its dollar reserves to Euro. It also explains why financial investors and speculators have in recent weeks accelerated their sale of dollars and purchase of other repositories of value, especially precious metals and oil. Rising financial speculation in oil markets has, in turn, accelerated the rise of its price.

Thus, the war contributes to the rising cost of energy in two major ways. First, it creates political instability and the fear of oil interruption. Second, it aggravates the accumulating U.S. debt and the weakening dollar.

The skyrocketing energy cost is bound to negatively affect our economy. The dizzying rise in the price of oil—up nearly 30% in two months—has begun in recent weeks to pull up the price of other motor fuels and heating oil. According to Peter Beutel, president of energy consultant Cameron Hanover, every penny increase in the price of gasoline costs U.S. drivers $4 million a day.

Considering that the price of gasoline has gone up by almost 30 cents a gallon during the last month, this means that consumers are spending $120 million a day more on gasoline than a month ago, or $120 million a day less on other goods and services. This is obviously an ominous economic sign for the holiday shopping season.

It follows from the above analysis that the simmering economic recession, precipitated for the most part by escalating energy cost, is largely a self-inflicted policy of war and militarism. Instead of blaming China or India for the rising price of oil, U.S. pundits and policy makers should place the blame where it is due: the neoconservatives’ saber rattling in the Middle East. Unless the rising cost of war and the swelling U.S. debt are reversed or contained, the dollar will continue to sink and the price of oil will continue to rise like a hot air balloon.

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Ismael Hossein-zadeh, author of The Political Economy of U.S. Militarism (Palgrave-Macmillan 2007), is a Professor of economics at Drake University.

 

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