Thursday, September 11, 2008

Oil Falls To $100; No Russian Effect?

The NYMEX crude oil contract is almost at $100, and Brent crude is below $100. We are therefore again right around the inflation-adjusted highs hit back in 1979...and much lower than the $147 per barrel of just a few months ago.

It appears that basic supply and demand forces are making themselves felt. Makes me feel good about my small bet on not signing up for a fixed price heating oil contract this year (they wanted almost $5 per gallon, which seemed to me to be just too steep an insurance premium).

Yesterday, there was talk that the Russians were going to team up with OPEC on oil supply and pricing issues. Not necessarily a full fledged member of OPEC, but a partner. That did not stop the downward trend in oil prices.

If OPEC could get more of the world's oil suppliers into the cartel, then it is true that the incentives of the cartel lean more towards restricting output and higher prices. Marginal revenue from the cartel's perspective decreases in market share, and the cartel also faces a lower elasticity of supply from the rest of the world -- both forces tending to raise prices.

But the issue of course is that as you add more members, the incentives for free riding, and disagreements over objectives, may increase. Personally I would be worried about adding as a partner to my oil cartel a country that holds the world's largest reserves of natural gas.

Think about it.

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