Is Oil as Expensive as it Seems?


The price of oil has doubled over the last 12 months reaching over $122 per barrel on May 6. What have caused that drastic increase and is it really a new record?

Indeed, oil prices are denominated in U.S dollars and as the greenback depreciates the price of oil is naturally going up. It is estimated that each time the dollar falls one percent, the price of the barrel rises by $4. In fact, a big influence on oil prices has been the U.S monetary policy. Since September 2007, the Federal Reserve has slashed interest rates by 3 percentage points. The lower yield not only accelerated the amount of dollar losses but also caused a flow of investment capital to more speculative markets like oil.

On the other hand, some economists are arguing that oil production is about to reach its limits and that each disruption in oil supply brings the rise in price. But, is oil as expensive as it seems? According to Deutsche Bank, taking into account the annual average income within the Group of Seven countries, the price of oil would have to rise to $134 a barrel to reach the 1981 level. Also, while spending on oil today constitutes only 3.5% of global output, in 1980 it was 5.9%. Other things being equal, oil will not consume as big a share of the world's GDP unless the price reaches $150 a barrel. Furthermore, the spending on energy make up today only 6.6% of Americans' disposable income, in 1980 it was 8%. To drive these expenditures to 1980 level, the price of crude would have to rise to $145.


Anna Fedec, analyst@tradingeconomics.com
4/29/2008 12:05:53 PM