The Buffalo News, June 23, 2008

The price of oil just soared above $130 per barrel. Consumers want to know why oil prices are so high and what they can do about it.

Politicians claim that greedy oil companies are hiking prices to fatten profits. But weren’t oil companies greedy in 2002, when the price was $26 per barrel?

Another theory is that oil companies have colluded to cut supply. But since prices started rising in 2003, worldwide annual crude output is up almost 1.4 billion barrels. Also, if collusion is so profitable, then why weren’t oil companies colluding sooner?

The real culprit behind high oil prices isn’t a restriction in supply but an increase in demand.

As China’s and India’s economies boom, they require oil. From 2002 to 2006, China’s petroleum consumption rose almost 9 percent per year. This increased demand bids up oil’s market price, which signals the scarcity of the resource.

High oil prices cause businesses and consumers to economize consumption, perhaps through different production techniques or car-pooling. The high price also creates incentives to locate and develop more oil reserves.

The recently discovered Carioca oil field off Brazil’s coast may hold up to 33 billion barrels, which would make it the third-largest field in the world.

Besides increased consumption in developing economies, the U. S. dollar’s fortunes have affected demand for oil. The dollar recently sank to record lows against other major currencies. Because oil is traded on a world market, when the dollar falls, the price of oil, measured in dollars, rises.

Speculation has also played a role in the record-breaking demand for oil. With the world banking system sputtering and hostilities between OPEC countries and the United States simmering, there is a small but real threat that the global petroleum supply could be disrupted. If that happens, the oil prices will spike dramatically. Speculators are aware of this possibility and are hoping to profit from a potential jump in prices.

Although the current high price of oil is “correct,” policymakers have options to provide relief. The federal government could relax restrictions on the development of offshore and Alaskan oil reserves. This would lower prices and reduce our reliance on foreign sources.

The federal government could also begin selling off the Strategic Petroleum Reserve. With oil at more than $130 per barrel, it seems silly to spend tax dollars to keep barrels off the market.

High prices serve as signals and provide incentives for corrective action. Current oil prices are painful, but they reflect underlying economic realities. Instead of blaming the price messenger, we should seek policies that strengthen the dollar and make it easier to find new oil supplies.

Robert P. Murphy is a senior fellow in business and economic studies at the Pacific Research Institute.