James Hamilton considers why oil prices are rising:
If both Russian and Saudi production have in fact peaked, the global peak cannot be far off, even if the Brazilian find is borne out. But I nevertheless am not persuaded that any of these news items is the primary explanation for the recent highs in oil prices.
[…]
The reason is that we’re seeing similar increases since the start of the year in the price of virtually every storable commodity. The 12% increase in oil prices this year is in fact just the median for the group of 15 commodities graphed below. It seems to me we should be looking for a single explanation behind the common behavior of the group, rather than try to develop a separate theory for aluminum, barley, coffee, cocoa, copper, corn, cotton, gold, lead, oats, oil, silver, tin, and wheat.
You can’t attribute much more than half of this increase in commodity prices to the decline in the value of the dollar. The dollar price of a euro (the bold red line in the graph above) is up only 7% for the year, which is less than the price increase for all but 3 of the 15 commodities shown. Another way to make that point is to recalculate the above graph in terms of the price of the commodities in euros rather than in dollars, as is done below. We’re seeing significant relative price changes, not simple depreciation of the dollar.
I also find it implausible to attribute the commodity price increase to a surge in demand. The economic news over the last three months has been very convincing that output is slowing, not accelerating.
Instead I believe that the price of oil, like the price of all the other storable commodities, and for that matter the dollar cost of a euro, is primarily responding to the Fed’s decision to move the real interest rate strongly into negative territory.
It seems to me there are a number of possible explanations for generally rising commodity prices. There are the reasons that James suggests:
- The falling dollar especially since many of these commodities are denominated in dollars.
- Increasing demand.
- Static or even dwindling supply.
- Fed policy.
But I think that a couple of other reasons should also be considered. Many of the commodities are highly dependent on the price of oil and may be especially so since so many of their producers subsidize oil consumption, selling gas below world market prices. That’s an effective subsidy on inefficient methods of production.
Is it possible that oil producers, particularly the KSA, are optimizing their medium or long-term cashflow by reducing their production? They’ll reduce their near-term production costs that way and the rise in oil prices due to demand factors keeps their cashflow at acceptable levels.
