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I watch the 2008 price spike carefully and noted Krugman's comment that they was NO INCREASE IN OIL HELD IN STORAGE during the 2008 run up in price. Krugman mentioned that in 1979, the last time we had such a run up in price, you had massive increase in oil inventories, indicating people were buying and sitting on it expecting the price of oil to go up. Krugman also noted that he would like to have inside information on OPEC members actual reserved (Not the published reserves that no one trust, the actual reserves) and then and only then could he tell you if the price was permanent or not.
Given that inventories were low, the price kept on raising. People were betting that it would continue to raise, so they bought oil as soon as it became available. This was the speculation that was driving the price up, fear that the shippers and distributors of oil would lose money do to the increase in the price of oil (What they were selling at $3 a gallon was being replaced by gasoline costing them $3.10). Now some true speculators entered the market at the peak, but those same speculators also drove the price down after it had peaked and started oil's rapid decline (Oil's drop to $30 a barrel was driven by Speculators, just like the peak price was driven by Speculators). That is what Speculators do, they try to guess what oil will be in three months, and then make a bid. When the US economy collapsed do to the high price of gasoline, the same speculators that drive it to its peak, then drove it to its lowest price.
The problem is the largest group of "speculators" were NOT people who previously had no interest in the price of oil, but those people who have ALWAYS been dealing in oil. It was such retailers and distributors that started the bidding war and did most of the fighting (Both up and down). They needed product to sell and as long as inventories were low they had to out bid other such retailers and distributors. Told the end other speculators entered the market, but made the switch from bidding high to bidding low as price peak and it became clear US use of oil started to drop (And US Inventories started to increase). after about three months (and the price hit rock bottom) these late speculators withdrew from the market, but you still had the Retailers and Distributors to bid on the oil (And the price of oil slowly increased). The South retained the highest prices for the longest time for it was hard to get gasoline into that area, and thus you had a continuing storage do to lack of gasoline caused by local conditions (The pipeline from Texas as maxed out and any additional gasoline needed had to be trucked in, during a period a lot of independent truckers had parked their rigs do to the high price of diesel). That lasted another 2-3 months, then it returned to a price similar to the rest of the country.
I read extensively during the price up and down, the shortage was REAL. Oil supplies were TIGHT and we can see this is the drop in domestic inventories during that period. Technically Supply was always 5% higher then demand, but inventories did NOT increase till after the peak. The difference between supply and demand dropped below 5%. While 5% sounds like a lot, it is probably a statistic quote, a product of the fact the the US does NOT count any oil the US Military buys and have shipped to its troops, places and ships that are refueled overseas (And the various countries where this re-fueling occurs also does NOT count it as an import). Given this tendency for no one to claim such oil as imports into their own country, it is "Lost". Every time oil supplies drop below 105% of Demand, you see a price spike.
Now, this year we have seen an increase in the price of oil, but inventories of oil have been increasing or steady. Retailers do NOT want to find themselves in a similar situation they were in 2008, so have tried to maintain inventories (But the fact we have many retailers, many distributors but just a few OWNERS of Refineries seems to have forced the price up, the retailers and distributors do NOT want to be caught without oil, it is their business to shop and sell oil and gasoline and will always bid the highest price for both).
My point is Krugman (and I agreed with him at that time) said if the price increase was the product of a real shortage, the price will stay high. No one expected the economy to collapse as fast as it did, nor that the drop in demand in Indian and China would have at great effect on gasoline prices in the US as it did (Leading to the drop in the price of gasoline).
Right now, everyone is trying to figure out what is production price of the marginal supplies of oil? A marginal supplier is a supplier of any product (in this case oil) whose cost of production is higher then all other suppliers of that product BUT the demand for for the item, at that marginal producers price, still exists. i.e. the next higher cost producer of that item, cost exceeds what people are willing to pay for that item (And as such can NOT sell the product do to excessive price). This is best shown by an example. Producers A can product 10 items at $10 each. Producer B can produce the same item, but his cost is $15, and he can supply 10 of the items at that price. Producer C also can produce 10 of the items but its cost would be $20 per item. producer D, can also produce 10 that item, but at $25 each. What is the price if demand is for only 10 of the item? That is $10 each, for the other three producer can NOT produce it at that price, but producer can meet the demand of 10 of those items at $10 each.
What happens if demand is for 11? Then the price will be $15 EACH. Producer A can only provide 10 of the items, thus we need one from producer B. The problem is the COST for Producer B is $15 EACH, so what is the price for all 11? The answer is $15 each. Producer B MUST sell at $15 for that is his costs, but Producer A can match that price AND sell 10 of the items for $15 each or a total of $150, with $50 prue excess profit. Now, this assumes perfect knowledge (and lack of such knowledge leads to price variation) but sooner or later both producer A and B realized that the price is $15. If the price drops below $15, then the 11th item can NOT be made (Producer's B COST is $15) AND the demand is for 11. Thus Producer A sells Producers A's item for $15 each, the going price for the item.
If 21 items are in demand, the price will be the cost of Producer C ($20 each) for the demand is for 21, but the marginal producer price is $20 each and thus the price for all 21 items.
As to oil, the cheapest producer of oil has been Saudi Arabia for decades. Libya has better oil (cheaper to refine and as such sells at a premium over Saudi oil) but it is Saudi Arabia that sets the total oil output (Saudi Arabia does this the old fashioned way, it restricts its oil production, even when the rest of OPEC is cheating and selling oil in excess of their production limits set by OPEC). Now Saudi Arabia has the excess production capacity to set world price for oil (Depending on what Saudi Arabia what the price to be, which Saudi Arabia controls by setting its own production limits).
Today, the problem is Saudi Arabia seems to be having problems. During the 2008 criss, all Saudi Arabia could increase in production was very heavy oil, which can only be refined in the US (What Saudi Arabia has been selling over the last 59 years is better quality oil, this is one indication that Saudi Arabia may NOT have the excess production capacity it has claimed it has had since the early 1970s). If the rest of OPEC production can be controlled (Or more likely, Saudi Arabia calculates its production level assuming the rest of OPEC is lying as to production limit) Saudi Arabia can set world wide oil prices. If Saudi Arabia can NO LONGER set price by restricting its own oil production, the question then shift to whose production cost is the highest AND still needed to match world wide demand? Every oil producer below that marginal producer's cost will get excess profits, but anyone's whose cost to produce oil is above that price will have wait, for their costs will be exceed what they can sell the oil for.
Such marginal sellers, thus set price. Saudi Arabia has been the marginal supplier since the 1970s, but what if it can NO longer do that? The drop in Oil usage in the US has NOT been in passenger car driving, but it industry, thus a upstart in the economy could see an increase in oil demand and thus price as we go up the list of marginal oil producers. Somehow the price will stall (And best case scenario) OR the price increase will force the US into another recession (and with the recession a drop in demand for oil and thus a drop in price as each marginal producer stopped pumping oil as its cost starts to exceed the price for oil).
Sorry, we a facing some hard choices, a series of short up swings in the economy, followed by a increase in Gasoline price then a collapse in the economy. Thus up and down economy is what no one wants to talk about for the best solution would be to ban private automobiles (and ups and down demand for oil tiled in with the up and down of the economy). No one knows if this is occurring NOW, for we do NOT have the information needed to make such an estimate. Krugman pointed that out in one of his article during the 2008 oil bubble. Krugman pointed out if this is a REAL permanent Shortage, the price will go up over the long term (and, in my own opinion, the shortage can best be addressed in the US by increasing gasoline taxes and then using those taxes to improve not only the highways, but other means of transportation).
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