Tuesday, September 06, 2005

"Razor thin" oil economics

Newsweek's initial economic analysis of Hurricane Katrina remains a cloudy one, but the tightening of supply in the oil market will leave prices set to expand, and not contract:

"You have always had problems of pipelines going out, refinery explosions or weather-related disruptions," says Goldstein. But the system had ample spare capacity to produce more crude oil, refine more finished fuels or store them both. A supply shortfall in one part of the system could be made up in another. The resulting price changes were typically small, a couple of cents a gallon or less.

"Today when things go wrong, you don't have these cushions," he says. It's possible to balance supply and demand only through price changes. Because fuels are so essential to most people and companies, the needed increases must be steep. Buyers don't quickly cut their consumption. Indeed, the fear of shortages could make things worse by inspiring people to fill up more often, says Goldstein.

It is this remorseless logic—the old law of supply and demand—that poses the greatest peril for the American and world economies. The most obvious danger is that there will be other disruptions that compound today's scarcities: another damaging hurricane; a terrorist act in the Middle East; a politically inspired production cut (from, say, Iran); political unrest in a major supplier (say, Nigeria); an unplanned pipeline or refinery outage.

I think a slightly bigger picture is provided by The Economist:

Though America’s economy has recently posted enviable growth rates, these have been kept up by consumers who have run down savings and taken on debt in order to keep spending growing faster than their income. With consumers stretched thin and interest rates rising, a prolonged period of high petrol prices might well force households to retrench, at least temporarily. Mr Rosenberg calculates that every one-cent rise in the price of a gallon of petrol takes $1.3 billion out of consumers’ pockets, which could trim as much as a full percentage point off consumer spending this winter.


Even in less-thirsty Europe, there are fears that economic recovery could be choked off in its infancy by the steady upward march of prices for petrol and heating oil. That would weaken another of Asian exporters’ main markets and leave the world economy looking vulnerable. If the damage Katrina has done to the Gulf's oil-pumping capacity forces Americans to shop abroad for more fuel to feed their appetites, it could be a long cold winter for everyone.


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