Rising Cost of Fuel Term Paper

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Rising Cost of Fuel

The price of light, sweet crude oil on NYMEX has been above $40/barrel since late July 2004. By October the price of crude oil had temporarily surpassed $55/barrel. In the United States (U.S.), the Consumer Price Index rose by 0.6% compared to 0.2% for September. This was driven by a 4.2% increase in energy costs. In this paper, we will examine two arguments: the primary cause, or causes of the rise in the price of fuel and the impact on the U.S. economy.

The cause of the rise in fuel prices is the current demand for petroleum in relation to the supply. High demand is coming from increased industry in emerging third world nations including India and especially China which is developing a large car culture and whose manufacturing bases have grown very rapidly in recent years. Consumption in 2004 compared to 2003 according to DOE EIA estimates (International Petroleum Information):

World: 3.4% increase

China: 20% increase

UK: 8% increase

US: 6% increase

Asia outside Japan and China: 6% increase

Analysts have explained the low supply in the following ways: the war in Iraq that has destroyed some of Iraq's oil refineries, Hurricane Ivan's damage to offshore oil platforms in the Caribbean, YUKOS in Russia, civil unrest in oil producing West Africa especially Nigeria, worker's strikes and mechanical problems with oil production in Norway. World supply (specification) came in at 83 million barrels a day during 2004 in Department of Energy EIA calculations (International Petroleum Information). This rate of increase is faster than that of any other date in the past.

This spike was largely without the immediate causes of the fall of 2004. During this period the Bush Administration was expanding the Strategic Petroleum Reserve at a rate of 250,000 barrels per day. Analysts vary in their explanations of the price increases. One factor cited is that winter in the U.S. was colder than usual, though this became less relevant as spring approached. Another reason is the continued growth in world demand, helped by the stellar growth of India and China. Finally, the dollar continues to slump against the euro. Since oil is traded in dollars, the price must increase for OPEC to maintain buying power in Europe. Some analysts conclude from this that the increases are permanent and prices may go much higher. Goldman Sachs released a report predicting that prices could hit $100 at some unspecified date.

In April 2005 the price began to fall, reaching $53.32 on April 9. It then reversed course and headed to an all time high of $58.28, driven mainly by lingering concerns of a prolonged weak dollar.

In June 2005, the Bush administration announced that the Strategic Petroleum Reserve was full, and that the ending of federal oil stockpiling would increase supply and temporarily ameliorate fuel prices. However, crude oil prices surged to record highs eventually breaking the psychological barrier of $60.

While some see these increases in the price of oil leading to a recession comparable to those that followed the 1973 and 1979 energy crises, most economists see this as unlikely. All developed countries have high fuel taxes that decrease as oil prices increase and can be eliminated in the event of a dramatic price spike. The American Strategic Petroleum Reserve could serve a similar role in overcoming price increases in an emergency.

The western economies aren't as reliant on oil as they were thirty years ago, despite substantial growths in productivity. In the United States, for instance, each $1,000 dollars in GDP required 2.4 barrels of oil in 1973 when adjusted for inflation this number had fallen to 1.15 by 2001.

The price of light, sweet crude oil on NYMEX has been above $50 a barrel since March 5, 2005. After prices retreated for several months during the winter of 2004/2005 they rose to new highs in March and closed at a then new peak of $57.27 a barrel at the beginning of April 2005. On March 16, 2005, the price surpassed the October 2004 high of $55.17, closing at $56.46. On March 18th, the price rose to $57.60. This made the price 50% higher than its year-ago level. Later in April, prices began to fall, reaching $53.32 on April 9th. It then reversed course and headed to an all time high of $58.28, driven mainly by lingering concerns of a prolonged weak dollar.

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Prices retreated again and reached just above $47 a barrel on May 22nd. Oil prices jumped to almost $52 a barrel May 27th on expectations of high U.S. gasoline demand over the Memorial Day holiday and amid reports Saudi Arabia's King Fahd had fallen ill. "Any uncertainty in the Kingdom might cause prices to move higher,' said Mike Fitzpatrick, vice president for energy risk management at Fimat USA. 'We'll have to see how much movement there is if and when the King actually dies'" (Reuters). U.S. crude futures settled up 84 cents at $51.85 a barrel, building gains during the week of May 23rd to almost 11%. Brent crude gained 54 cents to $50.70 a barrel. It should be noted that the $50 to $60 range is still well below the all-time inflation-adjusted high seen in 1980 of $90.

This current spike was due to other causes than those that occurred during the fall of 2004. During that period the Bush administration was expanding the Strategic Petroleum Reserve at a rate of 250,000 barrels per day. Reasons for the current price increases vary depending on the analyst. One cause may be due to the fact that winter in the U.S. was colder than usual, although this became less and less relevant as year progressed towards spring. Another reason may be that world demand also continues to increase, helped by the stellar growth of India and China. According to Nariman Behravesh, "probably the biggest economy right now or the one that's having the biggest impact on energy markets other than the U.S. is China. China is now the second largest importer of petroleum. And it's really China that in some sense is setting the pace here. So China and China's developments and China's industrialization are clearly one of the biggest drivers of this picture at this point in time" (Lehrer, Fueling Inflation?). Finally, the dollar continues to slump against the euro. Oil is traded in dollars, and so in order for OPEC to maintain buying power in Europe, oil prices must increase. Some analysts thus feel that the increases are permanent and prices may go much higher. In addition, Goldman Sachs recently released a report predicting that prices could hit $100 at some unspecified date.

The price of light, sweet crude oil on NYMEX has been above $40 a barrel since late July 2004. By October the price of crude oil had temporarily surpassed $55 a barrel. In the United States (U.S.), the Consumer Price Index (CPI) rose by 0.6% compared to 0.2% for September. This was driven by a 4.2% increase in energy costs. "In real economic terms, prices are still below the levels of the early 1980s, but they have crept and diesel fuel in California now costs $2.27 per gallon while gasoline averaged $2.11 per gallon across the Golden State" (Szczesny). The cause is the current and expected demand in relation to the supply of petroleum. High demand is coming from increased industry in emerging third world nations including India and especially China, which is developing a large car culture.

World supply was at 83 million barrels a day during 2004 according to Department of Energy EIA calculations. "The recent oil price surge underscores the economic importance of oil and the reality that oil supplies are starting to dwindle. This is an issue that no longer can be ignored. During the past 15 years, world oil consumption rose an average of 948,000 barrels a day. It rose more this year, and the International Energy Agency forecasts higher consumption next year" (Attarian). The media have explained the low supply in the following ways: the war in Iraq, hurricane Ivan's damage to offshore oil platforms in the Caribbean, YUKOS in Russia, OPEC's, most notably Saudi Arabia's, failure to bring prices down via dipping into spare capacity, if it has spare capacity, civil unrest in oil producing West Africa especially Nigeria, worker's strikes and mechanical problems with oil production in Norway. In a recent satellite address, Federal Reserve Chairman Alan Greenspan said, "In the decades ahead, natural gas and oil will compete in the United States with coal, nuclear power, and renewable sources of energy. As the manner in which energy is produced and consumed evolves, it is not unreasonable to expect that, in the long run, the prices.....

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