One should look at the entire picture before panicking over rising oil prices. That's the message delivered by two recent research reports from the University of Pennsylvania's Wharton School.
Professors and industry economists advise, "It's a good time to shun hysteria, take a deep breath, and look rationally at the reasons for the price hikes, including their likely effect on the economy and on energy policy."
Rising oil prices do not affect the world's economies and industries as negatively as media reports suggest, as the world has become much more energy conscious since the oil prices hit an all time high in the 1970's.
"Recent high [energy prices] are not as bad as they look. The major reason is that we have become much energy efficient," said Professor Jeremy Siegel. "It takes less than half as much fossil fuel to produce a dollar's worth of gross domestic product, as it did in the 1970s. The U.S. economy is more diversified, with less reliance on energy-demanding manufacturing and more on service industries."
Today's oil prices are not even close to the 1970 prices, if adjusted for inflation.
"To match the 1970 oil prices, oil would have to soar to $90 a barrel," suggests Siegel.
Historically, not accounting for inflation, fuel prices in 1946 were at $1.17 a barrel, $3.56 in 1970, $28.46 in 2000, and by May 2005, crude oil has hit more than $70 per barrel.
Influencing Oil Prices
Saudi Arabia was always there to pump out more oil. But, they could not sustain such production over the long-term.
"Today we are stretched to the limit and the Saudis have nowhere near the excess capacity they did before," said Professor Richard Marston.
Public and private sector economists contend that a world wide supply-demand imbalance exists.
"It's clear that some part of the rise in prices is from the demand side as opposed to the supply side—and that's an important distinction," said Professor Nicholas S. Souleles.
Economics principles demand that prices go up when supply is dwindling or limited.
Countries—including the U.S., China, India and those in Europe—compete with each other for oil supply. Global oil demand has increased from 73.3 million barrels per day in 1997 to 83.6 barrels a day in 2005.
Oil output has decreased significantly over the past years due to political risks, and overproduction of oilfields that have become less productive.
"We are relying on a group of producers in very unstable regions of the world (such as Iran, Nigeria and Venezuela)," said Marston. "[There is] a whole series of hostile regimes producing oil and we are very vulnerable."
The worldwide supply is affected by the nuclear standoff in Iran. Political violence in Nigeria is affecting its contribution to world oil supplies.
Iraq's oil output is 10 percent below its production of a few years ago, which can be in partly attributed to terrorist attacks on pipelines and refineries according to media reports.
Oil companies have not invested heavily in exploration, refining and upgrading of equipment, as such undertaking was deemed to be too costly.
"[Oil companies] have invested in projects that could make a profit only if prices stayed high," according to recent McKinsey research. "The exceptions were the larger, globally integrated companies, such as BP, ExxonMobil, and Royal Dutch/Shell. They made strategic investments in large oil fields, deep-water drilling, and so on."
Today's Energy is More Efficient
The world has not forgotten the lessons learned from the Arab Oil Embargo.
"What's changed is [that] the economy is not as dependent on energy as it used to be," said David Wyss, chief economist at Standard & Poors.
Energy contributed around 7 percent of the Gross Domestic Product (GDP) in 2005, while it was 81 percent of GDP in 1981.
Auto manufacturers are producing more fuel-efficient vehicles, with "as much as 20 miles per gallon (mpg) per car today, compared with 15 [mpg] in 1981."
Homes have also become more energy efficient, better insulated, and appliances require much less energy to operate.
What influences energy the most is that manufacturing jobs have been outsourced and the U.S. economy has changed toward a service sector, with 80 percent of total U.S. GDP coming from the service sector.
Windmill projects are also getting under way. More than ten offshore windmill projects are under consideration in the U.S., including one at Cape Cod, one off Galveston Island, Texas, and one near San Diego.
Calls for alternative fuels are also getting louder. Ethanol produced from corn or sugar cane is up and coming. Ethanol made from sugar cane is sold at every gas station in Brazil and it is relatively cheap to produce.
"Today's world-record prices will probably be the last [world record highs] in history," said Professor Sergio R. Torassa of European University. "The process of technological innovation and active exploration should saturate the market with oil within a period of two to three years. Starting in 2010, supply will clearly exceed demand."
Price Gauging by Oil Companies?
"Exxon racked up profits of roughly $1,000 a second during the first quarter of 2006, while Shell earned about $785 per second, BP some $660 and Total $550 a second," said Ellen J. Silverman, owner of financial consulting firm Silver World.
European finance ministers held preliminary discussions about a windfall profit tax on oil companies during their May 5 meeting in Brussels. The problem with such a tax is that it has to be implemented worldwide to be effective.
Some in the current U.S. administration are also calling for a windfall profit tax, while others caution that this would decrease the amount available for exploration.
Past experiences say we shouldn't jump the gun. President Richard Nixon's price controls during the oil embargo resulted in long lines at the pump, while Japan just let the market decide on the price and there was plenty of gasoline available for everyone.
Wharton professors and a number of economists disagree that gauging is the factor.
"People are quick to say the price of crude is going up," said Jason Schenker, an economist from Wachovia. In reality "the market is trying to be efficient by rationally pricing into the market the [possibility of] genuine future disruption events."
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