January 15th, 2012
09:15 AM ET

Zakaria: Why oil prices will stay high

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By Fareed Zakaria, CNN

The next time you pay $3.50 dollars for a gallon of gas, stop and think about a basic rule of economics. When demand is low and supply is strong, prices should fall. Right?

Now apply that to oil. People drive less in the winter. The American economy is slow. The Euro Zone has stalled. China and India are slowing down. So demand for oil worldwide is low. So why is oil trading high at $113 a barrel, more than twice the price it was trading at five years ago when the global economy was booming? What in the world is going on?

There's a school of thought that suggests the global economy is doing better than we think. China and the U.S. are proving resilient to Europe's problems and so traders are expecting renewed demand in the world's two top economies. But another school of thought argues we're in the midst of a bubble. Speculators have been driving up the price of oil and eventually it will crash.

Now I think that the economic fundamentals really can't justify oil prices at their current levels. The real driver of high oil is not the stuff you find in the business section of the newspaper - the demand for oil in India and China. It's on the front page: Global politics.

You see, traders worry about risk. And the biggest risk to oil supplies is the threat of war in the Persian Gulf. Meanwhile, in Nigeria mass protests are raising worries about the supply of fuel from there. Venezuela is in a slow-motion collapse because of Hugo Chavez's mismanagement. There have also been protests in Russia, the world's top oil producer. And remember the fallout of the Arab Spring - Libya's oil production in 2011 was severely curtailed. Iraq continues to disappoint with its oil output and its recent political tensions certainly haven't made things any better.

So a mix of war rhetoric and local troubles in key oil states are factors driving up the price of crude. And that translates to higher prices at the pump. Now that logic suggests that prices will fall when the news calms down.

But perhaps not. Perhaps oil producers want these sky high prices. Usually the major oil producers understand that keeping prices too high in the short term means people start finding alternatives to oil. They start driving more efficiently; they start looking for alternate energies. But this time, oil states face crucial challenges. Look closer at the Arab Spring. The only oil rich country that has been forced into regime change is Libya. Why? The Gulf states lavish subsidies and salary increases on their citizens. They've upped spending to record levels to suppress any popular discontent.

I saw some striking numbers this week: Look at the "break-even" costs for the world's top oil producers. That is the minimum price at which these countries need to sell oil so that they can balance their budgets.

Russia now needs oil at $110 a barrel to manage its finances. For Iraq, the number is $100. Even Saudi Arabia now needs oil to trade around $80 a barrel just to balance its budgets. The numbers are also high for Algeria, Qatar, and Oman. Only a decade ago Saudi Arabia was able to balance its budget with oil prices averaging around $25 a barrel.

So now it is in these countries' interest to keep oil prices high, which they do by curtailing supply in one way or the other. This is perhaps the most lasting impact of the year of global protest: High oil prices.

So, the bottom line is an oil crash seems unlikely. Even though the engines of global growth are sputtering, be prepared for a period of expensive commutes. Maybe it's time to trade in your Escalade for a Prius.

For more of my thoughts throughout the week, I invite you to follow me on Facebook and Twitter and to visit the Global Public Square every day. Also, for more What in the World? pieces, click here.

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Topics: Economy • From Fareed • GPS Show • Oil • What in the World?

soundoff (448 Responses)
  1. Daniel

    The author had me agreeing with him right up to the end where he suggests you get a Prius. That is ridiculous for the following reasons; 1.) It is a car that is way too expensive for most people to buy, even with all of the taxpayer subsidied battery technology and material, 2.) most people would not realize a return on investment (for the extra expense of the hybrid) over the course of the car's life, 3.) the car is really a massive polluter thanks to all the lithium in it's batteries, 4.) only small or medium stature people can fit into it, and it's not much good to haul anything with. Not a practical suggestion for most Americans, Mr. Zakaria, not practical at all.

    January 17, 2012 at 2:10 pm | Reply
  2. alternativenergy

    Romney, Gingrich and the likes plus their sycophant rank and file need to go. Vote all Republicans out, at every level.

    January 17, 2012 at 2:11 pm | Reply
  3. Daniel

    As far as Canada goes their major customers are the USA, themselves, and other minor customers. Believe me North America is all good when it comes to oil requirements. Asia and Europe on the other hand... and they are some of our major customers for exports. Canada has lots of oil and sells lots of oil, but they don't sell oil to 'billions' of people like EMEA sources (and Russia) do. Ergo the focus on Middle East and African suppliers in the article. Just saying.

    January 17, 2012 at 4:55 pm | Reply
    • Mobius007

      Yep, N. America is blessed with a range of fossil fuels – not enough to meet all our requirements now or in the future, but we are in much better shape than many other regions of the world.

      January 17, 2012 at 8:03 pm | Reply
  4. db

    Fareed. I normally enjoy your show and analysis, but this one was, let's just say poor. After listening to that loon Krugman promote inflation and USD printing, to suggest there is something nepharious in the pricing of oil is a bit odd. Oil is priced in USD and the USD is being systematically debased as a matter of Fed policy. Price oil in gold or Swiss Franks or Canadian dollars – let me suggest that the price is flat to declining. Again, as a matter of policy, food and energy are excluded from core inflation numbers. What's happening to the price of food?

    January 19, 2012 at 12:17 am | Reply
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    March 31, 2012 at 6:58 am | Reply
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