# The Real Cause of High Oil Prices

- Link: https://greenlivingguy.com/2012/09/the-real-cause-of-high-oil-prices/
- Published: 2012-09-01T03:03:38-04:00
- Author: greenlivingguy

**An Interview with James Hamilton**

Nowadays the energy picture is confusing at best as the more information we are 
shown the more blurred our vision seems to become. Mixed messages, poor reporting
and a media hungry to sensationalize anything it thinks can grab a headline have
led to many wondering what the true energy situation is. We hear numerous reports
on how the shale revolution will transform the energy sector, why alternatives are
just around the corner, why advances in oilfield extraction techniques and new finds
will help to lower oil prices. Yet no sooner have we read these rosy reports than
we are bombarded with negative news on the Middle East, on why alternatives will
never compete, on peak oil and declining oil production.

So where do we really stand? Is our energy future one of falling prices and plentiful
supply or should we prepare for [declining supply and sky high prices](https://greenlivingguy.com/2015/01/oil-prices-china-demand-top-five-factors-affecting-2015/)?

To give readers a real understanding of where we are [Oilprice.com ](https://oilprice.com/)
was fortunate enough to speak with the world’s leading energy economist, Professor
James Hamilton. James is a professor in the Economics Department at the University
of California, San Diego. He has been a visiting scholar at the Federal Reserve 
Board in Washington, DC as well as many of the Federal Reserve Banks; and has also
been a consultant for the National Academy of Sciences, Commodity Futures Trading
Commission and the European Central Bank and has testified before the United States
Congress. You can find more of his work on his website[Econbrowser](http://econbrowser.com/)

In the interview, James discusses:

 **_    Why we shouldn’t get too excited with the shale revolution_
    The “Real”
cause of high oil prices_    The incredible opportunity presented by natural gas_
Why long term oil prices will creep upwards_    The geopolitical hotspots that could
cause an oil price spike_    Why sanctions could cause Iran to lash out_    Why 
speculators and oil companies are not to blame for high oil prices._    Changes 
we can expect to see under a Romney Administration_    Why Short term oil price 
forecasts are worthless_    Peak oil & Daniel Yergin

James Stafford: Oil prices have shot up in the last month. What range do you see
oil prices trading in over the next 12 months?

**James Hamilton: **Oil prices have always been very volatile.  If you look at 12-
month logarithmic changes in WTI going back to 1947, you come up with a standard
deviation of 0.27.  In other words, 25% moves up or down within a year are fairly
common, and 50% moves or greater have also been seen on a number of occasions.

If you look at options prices at the moment, they imply the same level of uncertainty
looking forward.  For example, somebody today is willing to pay $2.90/barrel for
a NYMEX option to buy oil in September 2013 at $120/barrel, consistent with a standard
deviation of annual log changes of 0.26.  The market is saying that prices that 
high or higher are not that remote a possibility.

And if you look at current fundamentals, it’s not hard to imagine big moves in either
direction coming fairly quickly.  The [price of oil](https://greenlivingguy.com/2008/12/oil-prices-up-on-talk-of-opec-cut/)
would surely collapse if we saw a significant economic downturn in China (something
nobody can rule out) or if Iraq succeeds in producing even half of its ambitious
production targets (though I personally consider the latter unlikely). On the other
hand, a military confrontation with Iran could produce a pretty spectacular price
spike.  If the Strait of Hormuz were to close, for example, it would represent a
shock to world production that in percentage terms would be 3 times as big as the
1973-74 OPEC embargo.

Because the demand for [oil is so insensitive to the price](https://greenlivingguy.com/2008/12/oil-prices-up-on-talk-of-opec-cut/)
over the short run, and because there is little excess capacity in the world at 
the moment, even small disruptions or additions could produce big price changes.
For this reason, I do not have a lot of confidence in anybody’s near-term oil-price
forecasts.

On the other hand, I think we understand pretty clearly the main factors [behind the overall increase in oil prices](https://greenlivingguy.com/2026/01/organic-cherries-the-truth-behind-their-price/)
since 2005.  Demand for oil, particularly from the emerging economies, has grown
significantly, and we have had a hard time increasing global production.  The single
most likely outcome is that both conditions will continue to be with us.  The most
likely scenario is that the next decade will look something like the last, with 
oil prices volatile but exhibiting an upward trend.  
 **James Stafford: **For the
past century or so, economies have generally been built upon energy. The economies
with access to plentiful, cheap energy have developed the most. With the stagnation
of oil production growth, how do you suggest economies could continue to grow from
here? Should we stop expecting to see constant economic growth as the norm?

**James Hamilton:** I think this has put a significant burden on the oil-consuming
countries.  These economic problems have been compounded by the fact that some of
the key manufacturing that once came out of countries like the United States and
Japan has now been taken over by the emerging Asian economies.

But there is still a strategy for trying to take advantage of the resources we do
have.  The United States has had astonishing success in producing natural gas.  
This could be the basis for a renewed manufacturing advantage, a new source of U.
S. exports, or an alternative transportation fuel.  We should be looking for regulatory
reform and infrastructure investment to encourage consumers and entrepreneurs to
adopt alternatives to conventional gasoline-powered vehicles.**
 

James Stafford:
Apart from the Iran and Syria situations – are there any other geopolitical risks
that could lead to increased volatility in the energy markets?

**James Hamilton:** The list of oil-producing countries is almost a Who’s Who of
world trouble spots.  There is ongoing unrest in Sudan and Nigeria, and it wouldn’t
take much to see a major turn of events in Venezuela and Kazakhstan.  Iraq, a key
hope for future increases in production, has been a place of conflict for most of
the last three decades.  The same forces that disrupted production in Egypt and 
Libya last year could easily return.  And the key worry about Syria and Iran is 
the possibility that instability there could spill over into other nations of the
region.   
 **James Stafford:** Even though many Asian nations have found a way 
to continue trading with Iran, its economy is still suffering from high inflation
and high unemployment. Do you believe that the US Sanctions are having enough of
an impact on the Gulf state’s economy to force them into a deal over their nuclear
program?

**James Hamilton: **I was surprised that the sanctions were as effective as they
were in preventing Iran from selling all the oil it wanted.  But the other key element
of that diplomatic strategy is the assumption that Iran will respond to economic
pressure by acceding to U.S. demands.  The other possibility is that, if significantly
wounded, the regime would lash out more desperately.  This looks to me like a scary
situa
tion. **James Stafford: **Whenever oil prices spike politicians are quick 
to blame speculators and oil companies for manipulating the markets. Are you in 
agreement with this – are speculators and oil companies to blame? Or are there other
factors that are overlooked deliberately or otherwise by the mainstream media?

**James Hamilton: **The story is pretty simple, and even though politicians may 
try to distort it, you’d hope that the media would do a better job of reporting 
the truth than they have.  World oil production was basically stagnant between 2005
and 2008, even though world GDP was up 17%.  With economic growth like that you’d
normally expect increased demand, particularly from the rapidly growing emerging
economies, and in fact China did increase its consumption by a million barrels a
day over these 3 years.  But with no more oil being produced, that meant that the
rest of us— the U.S., Europe, Japan— had to reduce our consumption.  It took a pretty
big price run-up before that happened.  To those claiming the price is too high,
I would ask, how high do you think the price had to go to persuade Americans to 
reduce oil consumption by a million barrels a day?
 **James Stafford: **Could you
let us know your thoughts on the shale revolution. How do you see it playing out
and do you think we have been oversold on shale’s potential?

**James Hamilton: **This is a real success story, and a primary reason that U.S.
production is now rising rather than falling.  But there are several key points 
to keep in mind.  First, it is not cheap to produce oil with these methods— tight
oil is never going to be the reason we get back to $50/barrel.  Second, we’re likely
to face much steeper production decline rates from individual wells than was the
case for conventional oil production.  The same also applies to deepwater production.
So those who think these new technologies will put us back in the world we once 
knew are in my opinion missing the big picture.
 **James Stafford:** Drilling technology
advances, new oil finds and now all the hoopla over shale oil – one would assume
we are swimming in the black stuff, yet we have seen no material increase in global
annual crude oil production for six straight years. Have we reached a period of 
peak oil? Or is Daniel Yergin correct in saying that we have decades of further 
growth in production before flattening out into a plateau?

**James Hamilton:** I do not think the expression “peak oil” is the most helpful
way to frame the question.  Too many people have a knee-jerk reaction as soon as
they hear the phrase.  I can’t tell you how many times I’ve seen people assume that
it means that we’re “running out of oil”, which straw man they then try to debunk.
I would instead call attention to the basic fact that the annual production flow
from any given field shows an initial period of increase followed by subsequent 
decline.  Anyone who tries to deny that has a serious lack of grip on reality.  
Production from the original Oil Creek District in Pennsylvania peaked in 1873, 
and from the state of Pennsylvania as a whole in 1891.  There’s a long, long list
of areas that have exhibited declining production rates for a long, long time.  
Global production nonetheless continued to increase for a century and a half, not
so much because we got more out of the old fields, old states, old countries, but
because we turned to new ones.  But that game is obviously not one we can continue
to play forever.

Yes, Yergin today is optimistic about the future.  But I remember that Yergin was
also very optimistic in 2005, and the last 7 years have not looked at all like he
was predicting they would.  We’ve increased production only a little bit since 2005,
despite tremendous incentives to do more.  I think many people are making a mistake
if they assume that world oil production is always going to increase, year after
year.
 **James Stafford: **What are your thoughts on the [Keystone XL Pipeline](https://greenlivingguy.com/2014/02/keystone-xl-pipeline-a-controversial-project/)–
is it something that needs to be pushed through after the presidential elections?
Or something the country can live without?

**James Hamilton: **It is ridiculous to see oil selling in Cushing at a $20 discount
to the world price and oil in North Dakota selling at a $20 discount to WTI.  Since
the 1860s we understood that pipelines were the logical way to transport oil.  Somehow
the Keystone pipeline became a symbol of some bigger controversies that in my opinion
should be completely separate from the question of the most economically efficient(
and for that matter, the most environmentally friendly) way to transport oil.

There are several work-arounds in progress, such as reversal of the Seaway Pipeline
and plans to build just the Gulf Coast portion of Keystone.  But I think that given
the magnitude of the drop in U.S. demand and success of North American production,
we’ll need additional measures.
 **James Stafford**: How would you see energy production
changing in the U.S. under a Romney Administration?

**James Hamilton: **Romney wants to be more aggressive in approving oil exploration
and development, and that should make a difference.  But it’s easy for the politicians
to overstate how much they can change.  The U.S. is moving ahead with tight oil 
production, and is going to do so no matter who is the president, because the economic
incentives are just too powerful for anybody to stop it.  On the other hand, it’s
a big world out there, and anyone who thinks that U.S. production alone is going
to make up for declines from mature fields and burgeoning consumption of emerging
economies is in my opinion way too optimistic.  The world faces a huge challenge,
and I think we need to take that challenge very seriously.

**James Stafford: **James, thank you for taking the time to speak with us.

Source: [http://oilprice.com/Interviews/The-Real-Reason-Behind-Oil-Price-Rises-An-Interview-with-James-Hamilton.html](https://oilprice.com/Interviews/The-Real-Reason-Behind-Oil-Price-Rises-An-Interview-with-James-Hamilton.html)

Interview conducted By. James Stafford of [Oilprice.com](https://oilprice.com/)

**_More On Green Living News from The Green Living Guy:_**

**_Green Lighting by Seth Leitman, Brian Clark Howard and Bill Brinsky_**

**_Do-it-Yourself Home Energy Audits by David Findley_**

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 The Green Living Guy, Seth Leitman is an independent power producer, a green living
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