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The Perilous Price of Oil - The New York Review of Books
With respect to the oil market in particular, I believe there are four major factors at play which mutually reinforce one another. Two of them are fundamental and the other two are "reflexive" in the sense that they describe tendencies in the market that themselves affect the supposedly fundamental conditions of supply and demand.
First, the cost of discovering and developing new reserves is increasing, and the depletion rate of aging oil fields is accelerating. This goes under the rather misleading name of "peak oil" —namely that we have approached or reached the maximum rate of world output. It is a misleading concept because higher prices make it economically feasible to develop more expensive sources of energy. But it contains an important element of truth: some of the most accessible and most prolific sources of oil in places like Saudi Arabia and Mexico were discovered forty or more years ago and their yield is now rapidly falling.
Second, there is a "reflexive" tendency for the supply of oil to fall as the price rises, reversing the normal shape of the supply curve. Typically, as the price of a product rises, producers will supply more. For oil producers who expect the oil price to rise further, however, there is less incentive to convert oil reserves underground into dollar reserves aboveground. Oil producers may calculate that they will be better off if they exploit their reserves more slowly. This has led to what may be described as a backward-sloping supply curve. In addition, the high price of oil has enabled political regimes that are both inefficient and hostile to the West to maintain themselves in power, notably Iran, Venezuela, and Russia. Oil production in these countries is declining.
Third, the countries with the fastest-growing demand—notably the major oil producers, together with China and other Asian exporters—keep domestic energy prices artificially low by providing subsidies. Therefore, rises in prices do not reduce demand as they would under normal conditions. This may be considered o
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