The unpredictable forces behind oil prices

For people who believe that oil markets are rigged or broken, the first week of May offered Exhibit A.

That week, the price of crude oil plunged more than $16 a barrel, erasing about $32 billion of the market value of Exxon Mobil and presaging an easing of prices at the pump, where the cost of a gallon of gas had hit record levels.

Loading...

Comments

• Weigh In
• Corrections?

Personal Post

More on this Story

• Auction from strategic oil reserve oil draws $3 billion of bids
• Oil prices fall Friday
• Stock market scores biggest gain in two years
• The unpredictable forces behind oil prices

View all Items in this Story

• Get more news and numbers on the market

Live Q&A, Monday, 1 p.m. ET

Outlook Live: Five myths about independent voters

Ask Now

On that Thursday alone, the price of oil fell off a cliff, tumbling more than $10 a barrel.

Yet the physical amount of oil in the market didn’t change that week. Libya’s oil exports had been offline for more than two months. In the oil world, the surface was relatively calm. But a couple of signs of economic weakness spooked traders, who suddenly worried that demand would be less than they had expected. Goldman Sachs, a believer in rising crude oil prices, predicted a temporary pullback. Poof! More than a tenth of the value of a barrel of oil disappeared.

For consumers, oil prices are like a bad case of malaria — feverish one month and tolerable another. Such wild fluctuation makes it nearly impossible to discern: What is the right price for oil?

Today’s crude oil prices are nearly 10 times as high as they were in 1998, and twice as high as in 2005. They hit a record of $147 a barrel in July 2008, only to sink to less than $40 a barrel by the end of that year.

In March, amid intense fighting in Libya, President Obama said that there wasn’t a serious supply shortage and that rising oil prices weren’t reason enough to tap the nation’s Strategic Petroleum Reserve. Then on June 23, he suddenly said that turmoil in Libya justified the largest-ever release of reserves.It was more of an economic stimulus than a national security measure.

Because oil prices fluctuate so much, however, it will be impossible to measure Obama’s success or failure. If prices continue to drop, as they were doing before his move, will he deserve credit? If they rise, will he deserve blame? If it works, will we want him to do it again?

That will come down to the question of price.

In a competitive market, the price of oil would be linked to the marginal cost of the next barrel. In other words, the price for the first 88 barrels would be affected by the cost of producing the 89th barrel, in effect the cost of replacing each barrel used.

But in the world of oil, it’s hard to say what that replacement cost is. Producing oil is not like churning out computer chips, where costs are similar everywhere.

In Canada, it costs somewhere between $40 and $60 a barrel to mine and melt the viscous goo known as tar sands that environmentalists would rather leave in the ground. Yet in the Gulf of Mexico, where giant drilling rigs plumb deep waters, the cost of finding and developing oilfields can be relatively modest. Chevron, for example, has a $7.5 billion platform that will tap into a half-billion-barrel field at an average cost of about $15 a barrel. In Iraq, it’s even cheaper. The country has giant, shallow fields as good as almost anything in Saudi Arabia. In some places, you could practically stick a spear in the ground and come up with oil. Those neglected fields are being rehabilitated — if fighting can stop long enough.