‘The Laws of Supply and Demand Do Work’

Mark Green
Posted April 11, 2012

Back in February we ran the chart below. Then, at a congressional hearing last month, API President and CEO Jack Gerard referred to it in testimony urging lawmakers to consider the effects of increased U.S. oil production on global crude oil markets. We’ve written about the effects of increasing domestic supply here, here and here.

Last weekend the Washington Post took issue with the notion that the basic laws of supply and demand apply to crude oil like they do other globally traded commodities. The article noted Gerard’s congressional statements about supply and market expectations and dismissed them:

"As Gerard told it, 'the price of crude oil over three days dropped $15 a barrel and continued to move down.' The lesson, he said, was that 'markets are driven on a global basis by expectation. If the market heard the president of the United States say ‘I’m serious about producing my vast energy resources,’ you will see an impact in the market.' The tale was an indictment of President Obama. But there’s one hitch, say oil experts. It doesn’t hold together."

The Post attributed the crude price plunge to other factors:

“The dizzyingly high (oil) price, and fears of an economic slowdown, triggered a wave of selling by oil investors or speculators, in part because of margin calls. The prices of equities as well as commodities such as corn and aluminum, unrelated to offshore drilling, also fell, reinforcing the argument that oil’s fall was a symptom of broader market conditions.”

Interesting, but we couldn’t help noticing the quote from one of the oil experts in the article’s very next paragraph:

“'There is no doubt that expectations are a part of price movements,'” says Ed Morse, head of commodities research at Citigroup.

Well, that looks like Morse basically just blew away the article’s argument that the supply/market expectations linkage “doesn’t hold together.” To be fair, Morse went on to say he thinks credit problems and the impending recession had more effect on crude prices than energy policy statements. But there’s no escaping the fact that the story’s own source acknowledged that market expectations – about supply changes, national policy shifts, political resolve – have something to do with crude oil “price movements.” API Vice President for Policy Analysis Kyle Isakower:

“We do not argue whether there was … an oil price bubble in July 2008. However, to claim that the signal sent to the market by lifting the presidential moratorium had nothing to do with the drop in prices that began the very next day stretches the limits of credibility. Given the concern many policymakers place on speculation in oil markets, here is a perfect example of a signal being sent to the market that changed traders’ thoughts about future prices.”

Supply and demand indeed applies to the crude oil markets. Increasing supply will exert downward pressure on the price of crude, which is critical since crude currently accounts for about 76 percent of the price we pay at the pump.  WTRG Economics’ James L. Williams:

“If we increase supply in the U.S., will there be an effect on crude markets? Absolutely. … If the U.S. increases domestic production, over time that’s going to bring prices lower. … The laws of supply and demand do work, even if it’s not as obvious as it should be. If we produce more, the price will be lower than it would have been otherwise. … I don’t care who increases oil production, it will decrease oil prices.”

Supply matters. Next.