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Wednesday, September 28, 2011

Oil Price Fluctuations

Neelesh Nerurkar
Specialist in Energy Policy

Mark Jickling
Specialist in Financial Economics

Oil prices generally increased from 2002 until mid-2008, collapsing with the economic downturn and then rebounding with global economic recovery in 2009 and 2010. In 2011 to date, the price of West Texas Intermediate crude oil has ranged from less than $80 to more than $110. These price levels and fluctuations stand in contrast to the relatively low and stable oil prices of the 1990s, when the level of WTI averaged about $20 per barrel. Periods of price increases raise economic and energy security concerns. This report provides an overview of factors that contributed to these oil price movements and may continue to drive prices in the future.

The United States imports about half of the oil and related liquid fuels needed to meet domestic demand. The volume of imports is down in recent years due to higher domestic production and lower consumption. Nonetheless, oil import costs have climbed due to higher oil prices. Rising oil prices can strain household budgets, widen the trade deficit, and create economic dislocations that reduce economic growth and lower employment.

The oil market is globally integrated and affected by a range of international supply and demand developments (market fundamental factors). Rapid, energy-intensive economic growth in developing countries raised global oil demand since 2002. Global oil supply was unable to keep up at previously prevailing prices. Depletion of some easy-to-produce resources, the oil industry’s difficult shift to more complex resources, geopolitical and weather-related supply disruptions, resource nationalism in oil rich countries, and the actions of the Organization of the Petroleum Exporting Countries all hampered supply growth. Oil prices rose to balance the market, pricing out some consumers and incentivizing additional supply. Supply and demand are inelastic to price changes, so it took large changes in prices to affect consumers and producers. However, demand is responsive to economic conditions. The recession, which caused a sharp decrease in global oil demand, proved to be a brief respite from high prices. Prices recovered as economic growth returned, particularly in developing countries, and new geopolitical supply disruptions again raised concerns about global supply. How these long- and short- term supply and demand trends develop will shape future price movements.

The rising price of oil has also raised concerns that non-fundamental factors increased prices even higher than justified by supply and demand. The inelasticity of supply and demand may have enabled other factors to further raise prices. Of particular concern has been the impact of rising financial investment in energy derivatives, as well as concerns about impacts of exchange rate fluctuations and price manipulation. These factors may impact the price of oil and oil products to some degree for limited periods of time, but it is unclear how large or enduring their impacts are.

A number of policy measures have been introduced by Congress and the administration to address both fundamental factors and non-fundamental factors. Fundamentals policy is complicated by the high upfront costs and long lead times that energy sector investments need to bear fruit. Much of the fundamentals focused legislation advanced in the 112th Congress focuses on the supply side of the equation. Non-fundamental factors have also been addressed, most notably as part of the Dodd-Frank Wall Street Reform Act of 2010. However, delays in implementation mean it is still unclear what impact these measures will have. Given the scale and complexity of the challenge posed by various drivers of the oil price, it may require a suite of options to best address oil price risks. Given the long lead times for investment and technology development and deployment to provide benefits, commitments to such measures may need to persist through continued upward and downward oil price fluctuations.

Date of Report: August 26, 2011
Number of Pages: 38
Order Number: R42024
Price: $29.95

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