Why Are Oil Prices Climbing So High?

In Depth

Read our series on oil, Oil Turmoil: Pricey Fuel's Impact.

Oil prices hit $106 a barrel Friday. That's a record even when inflation is considered. Oil now costs more in real dollars than it did at the height of the Arab oil embargo in 1973. But why are prices so high?

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ROBERT SIEGEL, host:

Oil prices hit a new record high of $106 a barrel today. That's a record even when you take inflation into account. In other words, oil costs more in real dollars than it did at the height of the Arab oil embargo in 1973.

Well, joining us to help understand why is NPR global business correspondent Adam Davidson. Hi, Adam.

ADAM DAVIDSON: Hey, Robert.

SIEGEL: OPEC says that oil reserves are now plentiful, so why is it so expensive?

DAVIDSON: Well, we consumers think of oil as someone digs up the oil, refines it and we put it in our car, maybe someone else puts it in a factory to run the power, and that is the standard picture. The supply of oil meets the demand of the people who want to use the oil. That is not what explains these high prices anymore. That explains prices up to, say, $80, $85. What's happening now is you have huge bundles of money from pension funds, from sovereign wealth funds, from speculative investors who are desperately looking for places to place their money. They are putting hundreds of billions of dollars into funds that just buy oil and trade it as a paper commodity.

SIEGEL: So we're not just talking about what we always refer to in these conversations, the rising demand of China and India - rapidly industrializing Asian economies - for more oil. That's been accounted for already in the rise of the price of oil. Now you're saying these are new players walking in and trying to buy oil.

DAVIDSON: Exactly. I mean, yes, China and India are huge new forces. They do explain a lot of the rise we saw from 30 up to, say, $80 a barrel, but they do not explain what's happening now. That demand is steady; it's not suddenly growing high. Let me give you some numbers I learned actually this morning and I found really shocking.

If you look at these funds of oil - basically they use oil like any paper traded investment, like bonds or stocks or whatever - in 2000, that entire market, everybody investing in this market was $9 billion, which isn't too much.

Today, it's over $250 billion. That is several months' worth of oil demand added to this market. The entire globe buy is around eight or $9 billion a day. So, you are talking about months' worth of oil demand added just from CalPERS, the California…

SIEGEL: Public Pension System.

DAVIDSON: …pension system, the Central Bank of China, Central Bank of Singapore buying this stuff because of they're afraid of inflation, because they're afraid of other types of investments and they're going into oil.

SIEGEL: Okay. Then what does the future look like for a barrel? Well, if that continues, if more and more enter that market, how high or low could it go?

DAVIDSON: This, like the subprime housing we saw last year, like so many times when we see these speculative bubbles, it can go much higher. People are talking very reasonably about $150 a barrel. The other thing with speculative bubbles, they can burst violently. And people are saying it's realistic for the price to just collapse all the way down to $30 in this year. Anywhere between 30 and 150 seems like a pretty reasonable guess.

SIEGEL: Yes. Well, what is $106 barrel of oil likely mean in the future for a gallon of gas at the pump?

DAVIDSON: Well, every retailer of oil is wondering this, too. Obviously, your business model going forward is very different at 150 than it is at 30, but I think it's safe to say they are going to be raising prices until they see that price collapse.

SIEGEL: What are the oil companies doing with all this money? Are they actually investing in new sources of energy? I assume they are making a lot more money as a result.

DAVIDSON: Yes. They certainly are making a lot of money on the upstream end of their business. That's where they actually go into the ground and get the oil. There is a lot of investment, not as much as you'd like to see because supply is not the issue. There is enough supply, so adding more supply is not going to impact that price. There isn't that incentive to find those new sources, which will be a sad thing for us a few years down the road presumably.

SIEGEL: Adam Davidson, thank you very much.

DAVIDSON: Thank you, Robert.

SIEGEL: That's NPR global business correspondent, Adam Davidson.

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