Why is the price of oil so high?

Extract Oil Worse, the pace of the pain has accelerated: As recently asFebruary, metro Atlanta gasoline averaged less than $3 a gallon. Why the run-up? Why the recent surge? One answer is "peak oil." That argument ¡ª dismissed a fewyears ago as alarmist, wacky or worse ¡ª now receives a moreserious hearing. The notion is that about half the oil beneath the earth has beenextracted. With demand still rising and production at its peak,prices can only keep rising, say peak oil adherents: $4 a gallonwill soon seem cheap. But there is a countervailing contention thatoil ¡ª like the Nasdaq before it ¡ª has become somethingof a "bubble," its prices puffed up by a massive flow ofspeculation. The Journal-Constitution recently separately spoke with an expertin the workings of investments and another expert on the geology offossil fuels. Q: A decade ago, crude oil was roughly $12 a barrel. Now it isselling for more than 11 times that amount. What is the key reasonfor the change? Fisher: The reality is that this is fundamentally a supply-and-demandsituation. There is so much growth in demand coming from emergingcountries, particularly Asia ¡ª especially China and India. It doesn't take very much in the way of demand to pull it prettydoggone hard. Schweitzer: It's supply and demand if you look at the growth of oil demandsince the mid-1990s. About 75 to 80 percent of the growth has comefrom developing-market economies. And in the last two years, 100percent of the growth globally has come from those countries¡ª including, but not at all limited to, China and India. Ithink the growth of the emerging economies is a secular [long-term]force that will be with us for the foreseeable future, except fortemporary interruptions. Q: Oil prices have nearly doubled in the past year. Even people whosaid there were fundamental reasons for the price rise were takenaback by the steep, steady climb. What has changed in the pastyear? Fisher: I think probably the biggest is the weakening price of the dollar.I've seen some analysis that shows that if the dollar were on a parwith the euro, the price of oil would be closer to $70 than to $120or $130. Schweitzer: I say supply and demand because supply has proved more restrictedthan many people expected it would be. There is a very strong casethat rapid demand growth has run up against limited supply growth. Q: How do you judge the action of traders and speculators in oil as acommodity? Are they to blame? Fisher: There has been some deterioration of the financial situation thathas moved a lot of people out of other investments and intocommodities. In fact, some of the other commodities have increasedeven faster than oil. Commodities is a place where a lot ofinvestors turn when there is a softening in other investments. Really, the effect can be explained by three things: supply anddemand, the fall of the dollar and commodity investing. Schweitzer: Now, I wouldn't want to argue that there is no role forspeculation in the rise of oil prices. There may be. But there aregood and solid reasons why oil should be up. ... It would not be atall surprising that there was some speculative element to the risein oil prices. Anytime a commodity is rising, the natural tendencyfor traders is to try to take advantage of that [which adds to thepressure upward]. But it is very difficult to prove the importance of speculation. Ithink that it's a story about expectations, that oil prices may goup in the future, and that can itself fuel a further rise inprices. Q: Have we reached peak oil? Are we close? Fisher: The idea of peak oil ¡ª that we are running out of oil¡ª is not a cogent scientific argument. There are assumptionsbehind peak oil. You have to know that you are halfway through [allthe world's oil]. To know you are halfway, you'd have to know howmuch oil is out there. And we don't know. The estimates vary by afactor of three. The resource base around the world is pretty substantial. And howmuch you are converting to supply depends on the investment made.We know oil is finite. We will peak on oil production one of thesedays. But that won't be from physical factors. It will be becausewe are moving to say, a hydrogen economy. Schweitzer: Non-OPEC supply has leveled off. There has been a decline inplaces ¡ª Mexico, the North Sea ¡ª and Russia, too, hashad its challenges. Even within OPEC, it's hard to say whatlimitations OPEC may be encountering. During the 1980s [after prices rose], demand contracted and pricescollapsed. OPEC knows those lessons. I would expect that if it iswithin their power, they would prefer not to see prices goever-upward. The analysis I've seen suggests that ... Saudi Arabia is bringingon a significant new field in a year or so. Q: What would it take to convince you that you are wrong about peakoil? Fisher: You'd have to go into a persistent decline of oil production for acouple of years, like the "peakers" say: 6 to 8 percent a year. IfI saw that, I'd stand up and salute. Schweitzer: I think markets work. We have had to adapt. What makes the rise inoil prices so disconcerting is the suddenness, without enough timefor people to adapt. I am not a believer in peak oil. I am a believer in the ability ofmarkets to help the economy to adjust, but that doesn't mean thatthe adjustment will be painless. Q: Which is more likely a year from now: oil down $70, to $55 abarrel, or up $70, to $185? Fisher: Absolutely nobody knows what is going to happen to oil prices.There are so many dependencies out there. But there are new projects coming that will add 12 to 15 millionbarrels per day in additional capacity in the next few years. Andsome will be coming online to increase production in the next fiveor 10 years. The amount of new projects coming online should be able to handledemand ... and might even exceed demand ¡ª depending on howmuch [a higher price] dampens demand. Schweitzer: To my eye, oil prices have now reached levels they are unlikely tohold for the next year. I think that we'll see some pullback inprices. I think that oil prices have reached a level that will extract morepain than the economy can withstand. We may very well expect apullback in demand as economic activity slows further. It's all a matter of degree. I would not expect prices to fall backto the levels of a year ago. I don't expect them to fall sharply. Unless there comes to be a lot more supply or a lot moreconservation ¡ª especially in the United States ¡ª I justdon't see the supply-demand balance improving back to the "good olddays" of $60-a-barrel oil.