Oil Prices

Paul Krugman thinks the recent run up in oil is speculation based:

This time, however, oil inventories are bulging, with huge amounts held in offshore tankers as well as in conventional storage. So this time there’s no question: speculation has been driving prices up.

Now, “speculation” isn’t a synonym for “bad”. If the underlying assumptions that seem to have been driving oil markets were right — namely, that a vigorous recovery is just around the corner, and demand will shoot up soon — then it would be perfectly reasonable to accumulate oil inventories right now. But those assumptions are looking less reasonable by the day.

For the most part, I agree. While what drives oil prices is very complicated (I don't think anyone fully understands it), the strength of the world economy is certainly a factor. To me, it looks like the recent run up is due to a bet by speculators (which, I might add, is not a bad word) that the international economy is going to pick up and the demand for oil in the near future is going to be far higher than it is right now. I believe the fundamentals of the economy are better than they were a few months ago. Traders and companies may very well agree with me and are bidding up the price.

With that said, I don't think the actual economy has improved all that much, just that now there's a lower probability of absolute and prolonged catastrophe. So maybe a little bit of the increase is justified by a partially stabilized economy, but I'm not sure all of it is. The economy is still very weak and will likely continue to be for quite some time. It looks like the economy is not going to return to what it was last September in the next couple of months. Anything longer than that is anyone's guess. California and other states are in a terrible situation and future commercial real estate losses loom large. People are reining in their balance sheets and even if we see slightly positive growth from here on out, I don't think we'll see a robust economy for at least for a couple of years.

To the extent oil prices reflect economic strength, some increase is probably justified. However, it'll be a long time before we see oil near $150 a barrel like it was at its peak and the doubling of oil from its low seems a bit excessive to me.

(picture from Calculate Risk via Matt Yglesias)