Bubble

Can we imagine filling up our cars with gasoline at P100 per liter?

In many countries, they are already paying that much for their gas. Europeans are paying more than twice what Americans pay for their gasoline.

After recent forecasts that food prices should begin relaxing in the second half of the year, oil prices now stand as the single most important factor pushing up inflation rates globally. Over the past few days, oil prices broke records on a daily basis.

Prices climbed up to well over $130 per barrel. Consider that only a short while ago, crude oil was sold at only $18 per barrel.

At the present price regime, a massive transfer of capital is happening. Wealth is being transferred from the oil importers to the oil exporters.

In Saudi Arabia, for instance, the cost of producing a barrel of oil is about $5. They are now selling that product at $130. Only narcotics traffickers enjoy a better margin on their investments.

Of course, it could be argued that fossil fuels are finite resources and should be priced at the highest possible levels. The present known oil reserves will not last humanity a few more decades.

Environmental conservationists should be cheering the present oil price regime. It discourages use of a non-renewable source of energy — at least in principle. The burning of fossil fuels causes global warming and all of its dire consequences down the road.

But they are not cheering at all. Modern life, for better or for worse, is organized around the assumption of cheap and abundant fossil fuels. Our modern cities are transport and energy intensive.

People do not work close to where they live. They ride cars, buses, trains and planes to get to do work. It is too late to reorganize our urban/suburban settlements. There is not enough time to reorganize the patterns of production and consumption that characterize contemporary life.

Imagine how much energy is required to ship, say, bottled water from the French Alps to a restaurant in Makati. Or how much aviation fuel will be consumed collecting experts from all over the world for a conference on global warming.

It is tempting to imagine that, perhaps two generations from now, new information technologies will enable people to work with global networks without leaving their homes and their tight-knit communities. That will lead to the deconstruction of the sprawling urban/suburban complexes that today require intensive use of fossil fuels.

But that will probably never happen. Having known people-to-people contact across continents, given all the expensive pleasures of jet planes, we can never return to hermit communities. We will, more likely, invent new ways of travel using alternative fuels rather than eliminate travel to reduce fuel use.

The earliest a commercial plane using hydrogen could be deployed, according to scientists, is 2030. Between today and that time, we will have to grapple with all the economic complications of a very high oil price regime.

The direst prediction about oil prices I have come across says that crude could cost $200 a barrel just two years down the road. Given the way the global economy is organized, that is an intolerably high price to pay. But then, less than two years ago, we thought that crude at $50 per barrel was an entirely laughable scenario.

Oil at $200 could abruptly end the “Pacific Century” — considering that nearly all the dynamic East Asian economies are oil importers. Only last week, Indonesia announced it would withdraw from the OPEC because the country had long ago become a net oil importer. Economic expansion has caused its appetite for oil to exceed its supply.

But wait. Last week, oil price futures began to soften. Crude prices slid below $130 per barrel.

This might be wishful thinking: one school of thought says that from last week’s high, crude oil prices could slide back to $80 per barrel before this year is done.

This school of thought says that over the past few months the spike in oil prices has not been due to supply and demand dynamics. It has been due to the weakening of the US dollar, the drop in interest rates and, consequently, the vast amount of liquidity in the financial markets in search of a hedge.

Cheap money encourages speculative activity. Large amounts of institutional funds have flowed into speculating on oil futures. That is the main driver that pushed up oil prices.

It was also the main driver that, earlier this year, caused a spike in food prices. Large investment funds began speculating on grains futures when buffer stocks thinned, bringing many poor societies on the verge of food riots. Improvements in the buffer stocks have since softened food price increases.

Following this line of thought, oil prices at their present levels could be no more than a speculative bubble. As interest rates rise to control inflation, the oil price bubble should soon burst.

We all desperately want to believe this to be true. But there is simply too much volatility in the global financial markets, and too many possibilities for more calamities such as the subprime crisis to break out, that it is difficult to abide by a preferred scenario.

We can only hope for the best and prepare for the worst.