Five Easy Oil Market Lessons

Posted on Feb. 19, 2007
By A. F. Alhajji
http://www.energytribune.com/articles.cfm?aid=393

Much of what you read and hear about world oil pricing is wrong. Here are a few things to keep in mind whenever you hear pundits talk about oil prices:

Lesson One: Prices in a competitive market are determined by supply and demand. If the world oil market is competitive, the price of oil on any given day is the result of the intersection between supply and oil demand. Through that process, we end up with “equilibrium” and the price is called “the equilibrium price.” There are no “shortages” in such a market. A shortage indicates that what people are willing and able to buy is more than what sellers are willing and able to sell. In the case of a shortage, prices will increase until we reach equilibrium: a balance between supply and demand. Economics 101 tells us that if the price for West Texas Intermediate is $75 per barrel, then the oil market is at equilibrium at that price and supply and demand are balanced.

We cannot have a market price of $75 and say that there’s a “clear imbalance between supply and demand,” as an OPEC document states; or “a fundamental imbalance between supply and demand growth,” as a senior official at a leading Canadian investment bank recently asserted; or a “misalignment between supply and demand,” as a well-known industry analyst has declared. Imbalance implies a shortage, and a shortage results in an increase in prices until we reach “balance.” Therefore, as long as there is a price – low or high – there is a “balance.”

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