Why Are Oil Prices So High?

Oil Prices Are Up 25% in the First Quarter of 2008:

Crude oil prices have increased 25% in the first quarter of 2008. According to most news sources, this is a result of surging demand from China and India, and a curtailment of oil supply from Nigeria and Iraq. (Source: BBC, Oil Price May Hit $200 a Barrel, May 7, 2008)

Supply and Demand Alone Are Not Driving Up Oil Prices:

Although these trends are accurate,the price of oil is being affected by more than supply and demand. In fact, the data shows global demand is down and global supply is up. Oil consumption decreased from 86.66 million barrels per day (bpd) in Q4 2007 to 85.73 million bpd as of this quarter. During this same time period, supply has increased from 85.49 to 86.17 million bpd. According to the laws of supply and demand, prices should have decreased.

Instead, during this same time period, they have increased almost 25%, from $87.79 to $110.21 per barrel of oil. (Source: EIA. See Google Spreadsheet)

Commodities Trading Is Driving Up Oil Prices:

Why? The EIA pins part of the blame on volatility in Venezuela and Nigeria. It also cites an increased flow of investment money into commodities markets. In other words, money that used to be invested in real estate or the global stock markets is now being invested in oil futures. (Source: EIA Short-Term Energy Outlook)

Furthermore, these funds are also being invested in wheat, gold and other commodities, causing high prices in food, which is resulting in food riots in less-developed countries. (Source: BBC News, Commodity Boom Continues to Roll, January 16, 2008; CNN, Riots, Instability Spread as Food Prices Skyrocket, February 18, 2008)

Today's high oil prices are also partially caused by a decline in the dollar. Oil is priced in dollars, so OPEC needs to raise the price of oil to maintain its profit margins. Furthermore, as investments such as real estate and stocks decline, traders are getting into commodities such as gold and oil futures. This is causing a bidding war, and a potential bubble. (Source: USA Today, Oil Briefly Spurts Near $104 per Barrel, March 3, 2008)

What It Means to You:

Expect continued high oil and gasoline prices until this bubble breaks...which could last at least until the end of the year. Like the housing bubble, this bubble will burst, but no one knows when, or at what level prices will return. Use the high prices as a motivator to decrease your use of oil and gasoline, as explained in articles in the "Related Reading" section of this article.