EconomistMom.com

Lots of attention on Fed Chairman Bernanke’s testimony today.  I don’t understand much about the mortgage market mess and how we’re trying to get out of it, because it’s more about financial vs. real economy stuff.  (Someone from the press tried to interview me about it yesterday before the AARP event, and I declined, admitting my ignorance.)

But I did understand the part where Chairman Bernanke explained that oil prices have risen because of good ol’ supply and demand:

…Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets.  Over the past several years, the world economy has expanded at its fastest pace in decades, leading to substantial increases in the demand for oil.  Moreover, growth has been concentrated in developing and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users.  

On the supply side, despite sharp increases in prices, the production of oil has risen only slightly in the past few years.  Much of the subdued supply response reflects inadequate investment and production shortfalls in politically volatile regions where large portions of the world’s oil reserves are located.  Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity and production.  Finally, sustainable rates of production in some of the more secure and accessible oil fields, such as those in the North Sea, have been declining.  In view of these factors, estimates of long-term oil supplies have been marked down in recent months.  Long-dated oil futures prices have risen along with spot prices, suggesting that market participants also see oil supply conditions remaining tight for years to come.

The decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices.  The precise size of this effect is difficult to ascertain, as the causal relationships between oil prices and the dollar are complex and run in both directions.  However, the price of oil has risen significantly in terms of all major currencies, suggesting that factors other than the dollar, notably shifts in the underlying global demand for and supply of oil, have been the principal drivers of the increase in prices.

Another concern that has been raised is that financial speculation has added markedly to upward pressures on oil prices.  Certainly, investor interest in oil and other commodities has increased substantially of late.  However, if financial speculation were pushing oil prices above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell.  But in fact, available data on oil inventories show notable declines over the past year.  This is not to say that useful steps could not be taken to improve the transparency and functioning of futures markets, only that such steps are unlikely to substantially affect the prices of oil or other commodities in the longer term.

And I found it interesting that in response to Bernanke’s testimony, the price of oil dropped today by a (second-largest) record amount, as Bernanke hinted that consumers were actually (what?!) responding to higher gasoline prices by purchasing less of it!–a supply-demand type lesson which apparently was news to at least some of those financial speculators!