November 5, 2008

Oil Prices: Trickier Than You May Think

The above chart of West Texas Intermediate Crude, a benchmark oil price, shows the parabolic rise and fall of oil from early 2007 to late 2008 (the snapshot was taken on November 6--click for updates).

The graph below, from BP's Statistical Guide to World Energy, gives Rotterdam product prices for gasoline, gas oil, and fuel oil to the end of 2007 (with a somewhat different visualization of the great movement).

Neither of these charts is adjusted for inflation. So how does the oil price look if it is so adjusted? Here's one look from Matt Simmons.

It's not clear what adjustment Simmons is using for inflation. Depending on the metric chosen, however, the chart will look very different. John Williams of Shadow Stats has pretty convincingly demonstrated the curious manipulations of the inflation statistics. Williams uses the methodology in place in 1980 to calculate inflation, a not especially strange notion. But when you do that, you get some surprising results.

An investment specialist, Bud Conrad, produced a chart of the oil price using the Williams data in June 2007, calculating its history using the 1980 CPI method. He finds that the 1980 barrel of $39.50 crude "is the equivalent of over $200 per barrel in today’s anaemic dollars." Conrad's chart doesn't capture the big surge in the crude oil price that took it from $70 at the end of the second quarter of 2007 to $145 in July 2008. $145 would equate to about the level it reached in 1990-91 before the First Gulf War, but falling well short of the big move up in 1979-1980.

While we're at it, we might as well look at the price of oil in terms of gold. This is also a good proxy for an "inflation-adjusted" oil price. The chart is interesting because it shows the oil:gold ratio at something of a critical juncture.

OK, everything should be crystal clear by now, so let's move on.

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