South-Western College Publishing - Economics  
Gas prices may not come down anytime soon
Subject The price of oil has been rising, and will likely to continue to rise.
Topic Supply and Demand; Equilibrium
Key Words

oil price; demand, supply, reserve

News Story

Our economy has seen oil price increases like this before, but this one may last much longer than any other.

Oil analysts argue that since early 2000, the per-barrel price of oil has increased by 62% to its current level of $40-$50 per barrel. In terms of dollar increases, oil now is much cheaper than it was in 1981, when it reached $73 per barrel in inflation-adjusted terms. However, our oil stocks are much smaller than they were historically, which is creating a concern that any small disruption - terrorist attack in the Middle East, political unrest in Venezuela - will cause prices to jump even higher.

Previous oil price increases were primarily supply shocks - oil-producing nations just stopped pumping oil. This time, though, we're seeing high prices even as oil producers continue to supply their raw materials. The biggest increases in demand are coming from China and India, two of the world's fastest-growing economies. China stated that its imports of crude oil have increased 40% from last year, and India's government expects its imports to rise by 11%.

Despite increased use elsewhere in the world, the U.S. is by far the world's largest consumer of oil, and it has seen its demand rise by almost 4% from year-end. Making the problem even worse, though, is the fact that average fuel economy in the U.S. has fallen since the mid-1980s, thanks to the popularity of SUVs and larger passenger cars.

Oil prices have been unstable recently because the reserve supply of oil is very thin. While US demand increased by 4%, its supply of crude oil increased by 5%. That 1% cushion is enough to take pressure off of the price, but not enough for people to really feel comfortable with the uncertainties surrounding the global flow of oil.

Another point of concern is that the future price of oil is rising as well. The contracted price to deliver oil six years from now (the "six-year futures price") has been increasing, and is currently around $35 per barrel, up from $25 two years ago.

(Updated October, 2004)

Questions
1.

Given the arguments in the summary, what has been happening in the market for oil in the US? Illustrate your answer with a graph of supply and demand.

2. What is the likely impact on current oil prices if the six-year futures price continues to rise? Illustrate with a graph of supply and demand.
3. The article also argues that SUV sales are beginning to slow down, at least in terms of the time cars are on sales lots until they are sold. Explain this economic phenomenon in light of this article.
Source Jeffrey Ball and Marcus Walker. "High Demand for Oil Could Mean High Prices Are Here for Long Run." The Wall Street Journal, 20 August 2004, http://www.wsj.com.

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