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Nobody can truly say what the real long-term price of oil should be — but it would not be out of line to look at the outcome of Thursday’s OPEC blowout and conclude that the world is getting closer to the right number.
Supply, demand, competition and innovation are performing the usual service to consumers and driving prices down. That the market is performing its proper function should be no surprise, although it has taken longer than many expected for the mighty OPEC cartel to run up against the hard realities of economics.
As the North American price of crude oil dipped below US$70 a barrel Thursday, with analysts calling for US$60 or lower soon, the world’s leading source of energy appears to be heading back to where it came from. At US$60, the real price of oil (adjusted for inflation) would be close to the level it reached during the first OPEC oil crisis in the 1970s.
There may be lots more to come. As the late, great market economist Julian Simon wrote 20 years ago, the long-term data on energy prices in a market economy “show an unambiguous trend toward lower costs and greater availability.” Increasing demand spurs high prices, high prices trigger corporate innovation, prices fall.
Oil is also political, where competition also rules. OPEC is clearly losing its weak cartel status, in part because Saudi Arabia appears to be engaging in a competitive battle for market share against new energy sources in the United States and elsewhere — part of the tight-oil technological revolution, a demonstration case for Mr. Simon’s conclusions.
But Saudi Arabia has geo-political motivations, too. Lower oil prices are weakening some key Saudi antagonists, including Russia, whose global swagger is highly dependent on the cash flow from high oil prices.
The real driver of oil prices, however, is innovation and competition. Whether the real long-term price of oil should be closer to its average price levels over the last century remains to be discovered as markets unfold over the next decades. For the first 70 years of the 20th century, the real price of oil averaged less than US$20 a barrel.
For the rest of this column, click here: http://business.financialpost.com/2014/11/27/terence-corcoran-how-markets-finally-beat-opecs-oil-price-chokehold/