EIA explores question of the moment: Why are oil prices so high?

Why oil prices are so high is a matter on the minds of many, especially the staff at the Energy Information Administration, the statistics branch of the U.S. Department of Energy. This month, in addition to its usual Short-Term Energy Outlook, the EIA published a supplemental report that details the reasons behind high oil prices. (On Nov. 28, the Associated Press reported that light, sweet crude for January delivery on the New York Mercantile Exchange rose 33 cents to $94.75 a barrel in electronic trading in Europe.)

Noting that crude oil prices have increased dramatically in recent years, a summary of the report stated, "the EIA believes that the following supply and demand fundamentals are the main drivers behind recent oil price movements:

1. Strong world economic growth driving growth in oil use
2. Moderate non-Organization of the Petroleum Exporting Countries (OPEC) supply growth
3. OPEC members’ production decisions
4. Low OPEC spare production capacity
5. Organization for Economic Cooperation and Development (OECD) inventory tightness
6. Worldwide refining bottlenecks
7. Ongoing geopolitical risks and concerns about supply availability.

"Oil markets have been drawing increased interest and participation from investors and financial entities without direct commercial involvement in physical oil markets,” the EIA noted. “The role of these non-commercial futures market participants in recent price developments is difficult to assess, particularly over short time intervals. However, general principles favor a focus on fundamentals rather than consideration of alternative price drivers, when the explanatory power of fundamentals is high. As outlined in the full report, EIA believes that fundamentals provide the primary explanation for the recent trend in oil prices."

Here is an excerpt from the EIA report:

"Strong world economic growth, especially in traditionally large oil-consuming regions, has resulted in strong world oil demand. When the volume of oil demanded exceeds the volume of oil supplied, oil prices rise to bring oil consumption in line with supply. Global oil consumption rose by 1.1 million barrels per day (bbl/d) in 2006, and is projected to rise by 1.1 million bbl/d in 2007 and 1.5 million bbl/d in 2008. China, the United States, and the Middle East countries are the main drivers of consumption growth, and China and the United States alone are projected to account for half of world oil consumption growth in 2007 and 2008. While high oil prices have helped to slow economic growth in industrialized countries such as the United States, the Chinese economy has shown few signs of slowing down. The economies of oil exporting countries in the Middle East and of Russia have also benefited from higher oil revenues, boosting oil consumption. In addition, the decline in the value of the dollar against other currencies also supports continued oil consumption growth in foreign countries.

"Oil is traded globally in dollars, and a declining dollar has made oil less expensive in foreign currencies than it is in dollars, since foreign retail prices are priced in local currencies."

To read the full version of the supplemental report, which runs six pages, visit: http://www.eia.doe.gov/emeu/steo/pub/special/2007-oil-prices.pdf.