International Law

China, India and Oil Prices

By Stan

Lots of folks these days are looking to lay blame for spiking oil/gas prices. Some of them gaze towards China and India, which do represent a large part of new growth, although not the majority of aggregate demand. Others have blamed the oil companies, oil speculators, and so forth. Paul Krugman is not amused with the argument that speculators are the problem:

Imagine that Joe Shmoe and Harriet Who, neither of whom has any direct involvement in the production of oil, make a bet: Joe says oil is going to $150, Harriet says it won’t. What direct effect does this have on the spot price of oil — the actual price people pay to have a barrel of black gunk delivered?

The answer, surely, is none. Who cares what bets people not involved in buying or selling the stuff make? And if there are 10 million Joe Shmoes, it still doesn’t make any difference.

Well, a futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price. And that’s true no matter how many Joe Shmoes there are, that is, no matter how big the positions are.

Any effect on the spot market has to be indirect: someone who actually has oil to sell decides to sell a futures contract to Joe Shmoe, and holds oil off the market so he can honor that contract when it comes due; this is worth doing if the futures price is sufficiently above the current price to more than make up for the storage and interest costs.

As I’ve tried to point out, there just isn’t any evidence from the inventory data that this is happening.

This is all way above my paygrade, of course, so I cannot comment directly on Krugman’s argument. I do, however, have a general question about all of this since I do not understand how the global oil market works.

OK, China has been growing at double-digit rates for many years now, although it looks like we are in for a bit of a slowdown in the near term. Still, even at slightly under 10%, that’s pretty fast growth. So here’s the question: if oil prices are a product of higher demand, and if a lot of this demand comes from places like India and China, why have prices moved up this rapidly?

Krugman charts oil prices over the past 9 months or so, and the price rise is dramatic, starting at 70-something dollars a barrel last summer to where we are now, in the mid-130s.

I know that China growth estimates have not changed radically during that time, and if anything, they have been revised downward. No startling news from India that I’ve heard either. So are we left with everything being explained from the supply side?

Very confused here . . .

Full post as published by China Hearsay on June 25, 2008 (boomark / email).