Oil at US$1,000 a barrel?

Oil at US$1,000 a barrel?

Yes, that's our future

WHAT is going on with our prosperity? There is talk of recession. Are things really so bad?

By Larry Haverkamp (Doc Money)
mail@AskDrMoney.com


19 August 2008

WHAT is going on with our prosperity? There is talk of recession. Are things really so bad?

Yes, especially in the US and Europe. They are the economic engines that drive the world's other economies.

Two huge problems there are also affecting us: A credit crunch and high commodity prices.

The credit crunch began with falling US home prices. It shut an important safety valve. If you hit hard times, you used to be able to sell your home to pay off debts.

Times have changed.

Consider this: One-third of US homes purchased since 2003 are worth less than what the owners paid for them.

Real estate website Zillow.com also reports that in the 12 months ending 30 Jun, 25 per cent of US home sales resulted in a loss. It is the worst on record.

It isn't just homeowners.

Banks have lost big money too. Now, they talk about stringent 'risk management'. What it really means is they cut back making risky loans, practically to zero.

Fewer loans mean less money flowing through the veins of the world's economies. Not as many deals get done. Unemployment rises. Consumers with less money slow the economic engine further.

To counter it, the US and other countries have lowered interest rates and given large tax rebates. Is it enough? In the old days, it would have been.

No solution?

Bad luck. This time we have been hit with a second whammy: Commodity shortages. They could kill us.

Really? Yes. Unlike the credit crisis, this is a problem that may have no solution.

Oil is key to everything. Petroleum accounts for half of all commodities we consume. Other energy, food and minerals account for the rest.

The good news is oil prices have been falling. The bad news is they are still sky-high.

Last Friday, oil prices closed at US$114 ($161), down 22 per cent from its high of US$147.

Oh sure, US$114 looks low. But you may have forgotten that oil was only US$70 per barrel one year ago. If you are really old, you may recall that oil prices averaged US$35 over the past 10 years.

The zillion-dollar question is: 'Are the recent high prices because of genuine shortages OR a speculative bubble?'

Raise your hand if you think it's a bubble.

Good, no hands. I see you agree with me that the shortages are genuine. I suggest you keep voting that way as long as oil remains above US$100 per barrel.

Many people think the problem is shrinking supplies. No. More oil is being pumped than ever before - 87million barrels per day - but demand is rising even faster. Most of it comes from new middle classes in developing nations.

When Ramesh in India trades in his bicycle for a motorbike, it uses only a little petrol. But it is happening millions of times over.

The persistently high prices indicate this new demand is not going away. Getting Ramesh back on his bicycle will be difficult. Maybe impossible.

Previous oil crises in 1972 and 1980 were different. They were caused by temporary supply shortages when Arab countries cut output for political reasons.

Now, oil wells are pumping at maximum capacity and it is still not enough.

The problem is new.

There is no solution. The poor will not volunteer to go back to subsistence living. (Good for them.)

Eventually, oil output will decline. Then, things will really get interesting. Oil prices will hit US$1,000 per barrel and go higher from there. The question is not IF it will happen but WHEN.

It's all because our earth is not expanding. Resources are finite.