Prices of oil defy logic of supply and demand
June 29, 2009
By Ethel Hazelhurst
The global oil market is trapped in a catch-22. Oil prices have risen so sharply in recent weeks that even oil producers are concerned.
The price surge to about $70 a barrel (R3.50 a litre) is driven by speculation - in other words punters are betting on future price rises. They have pushed prices so high that producers fear a rerun of the last year's speculative bubble.
In its June bulletin, oil cartel Opec warns that a slight shift in the market could tip the price into reverse.
But the catch is that producers need an even higher price. Without investment in production capacity, the supply of oil will not meet future demand. Opec says oil producers need a price of between $70 and $80 a barrel to make exploration and expansion worthwhile.
But as the price approaches the lower level, Opec fears the worst.
In its June bulletin, it points out that estimates for demand in the current year are constantly being revised downward. At the same time, supply of oil entering the market exceeds supply. But instead of falling, the oil price is rising.
"This combination of events defies logic," the report says.
The oil market is not the only one behaving perversely. Chris Harmse, the chief economist of Dynamic Wealth, has pointed out that trends in consumer prices in South Africa are out of line with the economic theory of supply and demand.
While consumers spent nearly 9 percent less in the first quarter, the consumer price index rose by 8.7 percent. The figures are adjusted for seasonal factors and multiplied by four to provide an annualised trend.
Markets, of course, work imperfectly. They are cursed with irresponsible speculation and bedevilled with what Reserve Bank governor Tito Mboweni refers to as "structural rigidities" - in other words, powerful players have their way with weaker players.
That is why there is constant pressure on governments to intervene in the markets and make things behave as they should. But the track records of governments that pursue the interventionist path shows they are usually less effective than the invisible hand.
For three decades after the National Party came to power in 1948, it pursued a policy of import substitution to protect local industry. The policy allowed major players to dominate the market - a domination that was challenged only when the economy opened up in 1994.
The shambles in South Africa's public health sector, after 10 years under Health Minister Tshabalala Msimang, is another example of the unintended consequences of intervention.
The minister made it clear soon after her appointment in 1999 that her prime aim was to stop pharmaceutical businesses making profits. She succeeded to a point, putting many small pharmacies out of business. But when her term as health minister ended last year, she had entrenched the position of big pharmaceutical retailers. And the poor patients seeking care at state hospitals - presumably the intended beneficiaries of her policy - were worse off than ever.
Sensible regulation could help redress imbalances - though striking the right balance is difficult. But it would be a mistake to replace the invisible hand with the dead hand of intervention.
The solution to market flaws lies in the human psyche. As long as people prioritise the purchase of a R920 000 Mercedes-Benz ML63 over their long-term interests, markets and economies will be unstable.
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