Why oil isn't so expensive after all

Source: Moneyweek.com

I was reading an email form an ex-colleague in America this morning. He was arguing that the oil price would hit $300 a barrel should the US invade Iran. This seems more and more likely in my mind as the rhetoric ratchets up - and I hold my head in despair. (aC: US$300 per barrel on pure speculation?? Can that still be considered speculation or a calculated move?)

I fear that an attack on Iran is becoming a real and present danger, despite US government denials. After all, I remember Donald Rumsfeld saying on TV soon after 9/11 that the US government hawks would not use the terrorist attacks in New York as an excuse to attack Iraq. We all know what happened next.

The thought of oil at $300 is shocking, but is it realistic? Isn’t oil really expensive at the moment as it is?

Well, although I believe that $300 a barrel is unlikely in the short, or even the medium term, but I don’t think that oil is particularly expensive at the moment, despite it being at historic nominal highs.

I expect the price to rise – we should easily see $100 a barrel next year… maybe even this year should the White House warmongers hit the red Iran button. (aC: Hmmm... somehow I can picture the US President having a physical red button labelled "War"... Not as hard to imagine, compared to a $300 per barrel of crude oil.)

If you adjust for inflation, the oil price peak at the start of 1981 was in excess of $100. We are still below that figure. But this is not why I believe that the current oil price is cheap. Let’s take a look at some figures to illustrate my point of view.

First, let’s ask ourselves a basic question – how much crude is there in a barrel of oil…

One barrel of oil officially contains 42 US gallons…
This converts into 35 imperial gallons…
There are 8 pints in a gallon…
That means one barrel of oil contains 280 pints...
WTI futures are currently approximately $87 a barrel…
That means one pint of crude oil costs 31 cents, or 15p in real money...

When put like that, it does not sound as outrageously expensive as some commentators claim. So, what else can you buy for 15p a pint?

I took a quick look around Tesco.com to try and find out…

One pint of milk costs 40p.
The one pint equivalent of Evian water costs around 70p.
The cheapest vegetable oil costs 39p a pint.
Extra virgin olive oil costs 227p a pint.

And then there’s beer… The average cost of a pint of beer in the UK is 250p, according to a report I read on the BBC. However, that’s not what it costs the pub. It is not exactly easy to find out how much your local boozer pays for its beer, so I have to go as far back as 2004 and a written submission from the Federation of Small Businesses to the Trade & Industry Committee.

In this submission, it was revealed that Carlsberg-Tetley charged 42p a pint for Carlsberg lager when it supplied it to a freehouse. You can expect it to be higher than this level now, but 42p for a pint of Carling is significantly higher than 15p for a pint of crude.

Now, of course we are not really comparing like with like here, I understand that. Crude oil is a feed substrate not a finished product like the items on my Tesco shopping list or a pint of beer from a brewery. However, I think for illustrative purposes it makes a good point.

The truth is that oil is NOT extortionately priced and it is almost inevitable that the price is going to rise.

Also worth noting is that in 1981, when oil hit its peak price because of the Iran-Iraq war, a pint of milk cost 17p. That is still more expensive than a pint of crude costs today; without even taking the monster of inflation into consideration.

Oil is cheap, despite the newspaper headlines. The world population is soaring and demand is rising significantly. According to US government forecasts, world petroleum liquids consumption is expected to increases from 83 million barrels per day in 2004 to 118 million barrels per day in 2030.

That’s an increase of almost 30%... and we are not finding enough new oil reserves to meet this demand.

The price of oil has to increase otherwise it would be betraying the laws of economics. I bet that in 10 year’s time after the Asian population has boomed and gentrified and peak oil has hit home hard, you will have to agree with me that oil at $87 a barrel was cheap, cheap, cheap… (aC: Just like how we thought the prices of 1981 were expensive when oil was just traded at $21 per barrel...)

(aC: Hmmm... But it leaves me to ponder - What if mankind discovered other renewable sources of energy that could replace or potentially replace crude oil? Would oil price still mindlessly climb up? Well, we all know from economics 101 what near perfect substitutes does to the price of a commodity. And in this day and age, is it impossible to make such a "discovery" in chemical laboratories? So before you buy go all out to buy gallons of oil futures at $89, think again...)