Understanding Oil Price Behavior through an Analysis of a Crisis

This article seeks to identify and explain both the fundamental and the more controversial elements that shape the dynamics of the oil market, using the recent oil crisis as the basic framework for analysis. The article suggests that the price of oil is essentially a function of the current and future spare capacity of oil. However, spare capacity alone cannot fully explain the extent and timing of oil price movements. Other important factors must be taken into account, including, above all, the expectations of market operators, who tend to be influenced by both the perceived current and future level of spare capacity and the unreliable data that have plagued the oil world since its inception. The article also suggests that bottlenecks in the oil refining system may play an important role in oil price movements, but tends to downgrade the importance of other factors, such as the influence of OPEC and financial speculation. Finally, the article suggests some reforms to make the oil market more transparent and possibly more stable, which is a prerequisite for making investments in energy efficiency and renewables in the near future. Copyright 2009, Oxford University Press.