Oil prices merit re-examining of supply/demand fundamentals

The supply and demand curves for oil aren't behaving the way we were taught they should. Consequently, every drop counts. Last year's relentless upward surge in oil prices was different from other increases, and not only for the heights it reached. Never before had the benchmark price of West Texas Intermediate (WTI) crude passed even $45/bbl, much less $50. And the caveat that "real prices were higher in the late 1970s" was little more than cold comfort.No, 2004's price surge was different because of what “the chart” said. Which chart? One of the first you see in Economics 101, with demand going in one direction along the price axis, supply coming the other way, and both intersecting nicely and neatly.The problem with "the chart," however, was that, although every student could see that supply increased with price, they could also see that at a certain point supply couldn’t go any higher because there was none left. The price of oil has surged plenty of times in the past. But spikes in other years always seemed to be associated with a particular event that could be cited as their cause: the Arab embargo of 1973–1974, the Iranian Revolution of 1979, or the disappearance from the market of Iraq and Kuwait in 1990–1991 following Saddam Hussein’s invasion of the latter. Even during price surges in those times, the world always had enough surplus capacity to produce more oil. Always, there was the belief that once the “temporary market situation” was resolved, there would be a return to normalcy. Normalcy was essentially guaranteed by the world’s spare capacity.Defying expectationsBut the oil price surge of 2004 wasn’t caused by any event. Instead, it could be explained by referring to that portion of "the chart" where the supply curve no longer follows the price curve. What's more, even as the price of oil moved into the $50 territory, on the chart the demand curve was defying Economics 101 lessons by refusing to flatten. To be sure, factors that are somewhat political could be blamed for this year's imbalance, as in the past. But it remains to be seen whether those factors are temporary or should now be considered permanent features of the oil industry’s landscape.