Basic Economics or High Stakes Speculation? 

Welcome to the great debate of 2008.  In one corner, basic economics rules the day and supply/demand issues remain at the forefront of all discussions.  In the other corner, naysayers claim speculators have prompted the dramatic run-up in oil prices and current levels have little to do with actual energy production and consumption. 

So, what gives?  Who’s right?  Are there any easy answers? 

Let’s Turn to the Numbers

With oil hovering just below $130/barrel, its price has virtually doubled over the past 12 months and has soared over 30% this year.  Currently, it stands about 20% above the previous record highs hit in 1980 (on an inflation-adjusted basis) and noted Goldman Sachs analyst Arjun Murti is on record as saying that $200/barrel over the next two years is well within the realm of possibilities.  Before you laugh (or cry), Murti first predicted a surge in oil to $105/barrel back in 2005.  Gasoline has followed in lockstep as related prices advanced to just below $4/gallon by Memorial Day and many travelers were forced to alter their vacation plans. In fact, a recent RBC Capital Markets survey showed that about 90% of Americans have initiated certain lifestyle changes as they tighten their belts because of the higher energy prices. 

Should the upward trend continue, undoubtedly consumer activity will be impacted to an even greater degree.  Stephen Brown, an energy economist at the Dallas Federal Reserve Bank, projected that $150/barrel oil will reduce GDP by around 1.8% in the first year, a pretty frightening thought considering the first quarter 2008 GDP grew at a feeble 0.9% rate.  At $150 oil, gas prices would move to about $4.50/gallon (and even more travel plans would be altered). 

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