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IX. MARKET SIGNALS AS PEAKING IS APPROACHED
As world oil peaking is approached and demand for conventional oil begins to
exceed supply, oil prices will rise steeply. As discussed in Chapter IV, related
price increases are almost certain to have negative impacts on the U.S. and
world economies. Another likely signal is substantially increased oil price
volatility.
Oil prices have traditionally been volatile. Causes include political events,
weather, labor strikes, infrastructure problems, and fears of terrorism.114 In an
era where supply was adequate to meet demand and where there was excess
production capacity in OPEC, those effects were relatively short-lived. However,
as world oil peaking is approached, excess production capacity by definition will
disappear, so that even minor supply disruptions will cause increased price
volatility as traders, speculators, and other market participants react to
supply/demand events. Simultaneously, oil storage inventories are likely to
decrease, further eroding security of supply, aggravating price volatility, and
further stimulating speculation.115
While it is recognized that high oil prices will have adverse effects, the effects of
increased price volatility may not be sufficiently appreciated. Higher oil price
volatility can lead to reduction in investment in other parts of the economy,
leading in turn to a long-term reduction in supply of various goods, higher prices,
and further reduced macroeconomic activity. Increasing volatility has the
potential to increase both economic disruption and transaction costs for both
consumers and producers, adding to inflation and reducing economic growth
rates.116
The most relevant experience was during the 1970s and early 1980s, when oil
prices increased roughly six-fold and oil price volatility was aggravated. Those
reactions have often been dismissed as a “panic response,” but that experience
may nevertheless be a good indicator of the oil price volatility to be expected
when demand exceeds supply after oil peaking.117
The factors that cause oil price escalation and volatility could be further
exacerbated by terrorism. For example, in the summer of 2004, it was estimated
that the threat of terrorism had added a premium of 25 - 33 percent to the price of
a barrel of oil.118 As world oil peaking is approached, it is not difficult to imagine
that the terrorism premium could increase even more.
In conclusion, oil peaking will not only lead to higher oil prices but also to
increased oil price volatility. In the process, oil could become the price setter in
the broader energy market, in which case other energy prices could well become
increasingly volatile and unpredictable.119
(p. 61 of the Hirsh report)
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