Oil reaches $92 after Iran says "Boo!"

Attributing every single rise in the price of oil to some minor Middle East-related event has become one of the most tiresome parlor games in financial journalism. What's driving the jump in oil prices is supply and demand. Jim Hamilton of Econbrowser explains this eloquently.

The problem with having too much money

With oil at $80 a barrel, the Gulf states are drowning in money. What do you do with it? You can put most of the estimated 628 billion windfall in boring Treasury bonds and you can splurge on neat stuff like building a massive Panama Canal-sized waterway to add 500 kilometers of waterfront. I hope they have fun while it lasts.

Oil at $80 is no surprise

Oil at a (nominal) record of $80 a barrel? Shocking! So say many OPEC members and ExxonMobil chairman Rex Tillerson, who are most puzzled that prices stay so high given that the market is well supplied with crude. Must be those pesky financial speculators!

This, of course, is nonsense (and predictable self-interested nonsense at that). While it's possible that investors may affect the price of oil in the short-run, prices have been high for many years, which surely means that the fundamentals are really in command.

And speaking of those fundamentals, let's see what the International Energy Agency expected for all 2007 back in January. Basically, demand was forecast at 85.77 millon barrels per day, while non-OPEC supply was expected to be 50.6 million barrels per day. In the most recent forecast, demand is now set at 85.9 mbpd, while non-OPEC supply is estimated at 50 mbpd.

In other words, demand has been higher than forecast, while supply has come up short (OPEC output has been broadly flat). That sounds like an Econ 101 recipe for higher prices to me.

Biofuel madness

It's amazing how the biofuels bandwagon has kept gaining strength despite the fact that it's one of the main factors behind the steep rise in food prices. (Note to The Economist: remember that oil is used to grow crops!).

People have tolerated this because biofuels have a warm, green image (not deserved in many cases). Who can possible be against the environment?

But its pretty clear that biofuels serve mostly one purpose: to benefit incumbent politicians. On production cost grounds, biofuels make no sense, with the possible exceptions of sugarcane and jatropha. Politicians love to subsidize non-viable industries with a good public image becase 1) not many objetct lest they be called anti-environment and 2) those subsidies come back as campaign contributions from agribusiness (which has no choice, given that it wouldn't exist without those politicians).

In other words, politicians subsidize themselves. Rent-seeking at its most perverse worst.