Monday, November 10, 2008

What Happened to Peak Oil?

Just a few months ago the world was running out of oil. Worldwide production had peaked and it was going to be all downhill from there. If this was the case, what should have happened to oil prices? If there is a short supply of a highly desirable product, the price should go upwards. If we were running out with few alternatives the price should begin to approach infinity.

Now that the price has dropped 56% from it's all-time high for West Texas Intermediate, what happened to the worldwide shortage? Did it ever exist?

My friend John Tamny of RealClearMarkets repeatedly claimed that oil prices were merely a product of a weak dollar. I gave him some credence, but thought he was blowing the dollar-oil link out of proportion.

Here's a graph I compiled going back to 1986, using data from the EIA, the dollar index from the Fed Reserve. I inverted the dollar index for illustrative ease. I adjusted the WTI price by the Consumer Price Index to get the values in constant 1986 dollars. A higher red line means a weaker dollar.
The correlation isn't perfect, but clearly John is on to something.

The quick and dirty theory goes like this. The value of the dollar weakens, which means we have to pay more for imported goods. Oil, more and more, is an imported good. Weak Dollar = High Oil Prices. Strong Dollar, like we've had over the last few weeks = Low Oil Prices.


zach wilson said...

maybe. Maybe the dollar is led by the price of oil. We could have an oil standard for our dollar and not even be aware of it.

Brian Shelley said...

Just eye-balling the data there seems to be a lagging correlation. The price of WTI seems to change a little after the dollar changes.

Interesting twist though. It made me think a little bit.