Power Window

After a precipitous drop last year, the price of crude oil has rebounded. By late October 2009, the price had edged above $80 a barrel, which is more than double the level it had reached earlier in the year. But since it is being compared to mid-2008 prices, which were nearly twice as high, $80 seems almost reasonable.

Unfortunately, that price level could be evidence of some serious problems with petroleum production. Even after adjusting for inflation, $80 is among the highest prices for a barrel of crude oil on record. And while some experts like to claim that this price spike, and the one before it—and the one before that—are due to speculation in the oil market, it’s worth considering whether these price jumps might be due to hard, physical limits to what suppliers can now produce.

RECENT OIL PRODUCTION VS. PRICE

PRODUCTION VS. PRICE—FIRST OIL CRISIS

Data from the Energy Information Agency shows
the relationship between crude oil production
and nominal prices.

To check this hypothesis, it is instructive to chart crude oil prices not against time, but against production. Do this for the past few years of data, and one can see that crude oil didn’t respond to higher prices the way that economics textbooks would suggest. In the face of growing demand from Chinese manufacturers and American motorists, petroleum producers couldn’t budge production much past 75 million barrels of oil a day. Instead of raising production to meet demand, they raised prices until consumers cried uncle.

As demand fell in the wake of the global economic crisis last year, prices retraced the path they followed on the way up. It seems unlikely that a speculation-driven bubble would follow this curve both on the way up and the way back down.

One can also compare this to another instance in which worldwide oil production reached a limit, albeit an artificial one: The oil crises of the 1970s. The Arab oil embargo of the