The “Oil Standard”

Carnival of the Capitalists is up and there is an interesting article by James Hamilton at Econbrowser entitled Oil at $15-30 a barrel?. In the energy chapter of the Economic Report of the President there is this statement:

Although oil prices have risen to more than $60 a barrel in recent months, they have averaged as low as $25 per barrel within the last five years. Having experienced past volatility in oil prices, oil companies report using a working assumption of $15-$30 per barrel for the future price of oil when making long-term investment planning decisions. (emphasis added)

Hamilton uses a variety of finance techniques to investigate the possibility of returning to prices of $15 to $30 a barrel. What struck me about the chart he shows of oil prices in 2005 dollars, is how remarkably stable oil prices were in the period from 1986 to 2004. Energy Bulletin has an article entitled The End of the Oil Standard and there’s this paragraph:

According to Pennwell’s Energy Statistics Sourcebook, OPEC production declined from 30.67 million barrels per day in 1979 to 16.02 million barrels per day in 1985. The same source list OPEC’s maximum sustainable production capacity as 34.4 million barrels per day in 1985. By the end of 1985, OPEC had 18 million barrels per day of shut-in oil production capacity. It became clear that there had to be a price ceiling as well as a floor. This was the price band.

Now Energy Bulletin’s final paragraph:

Was the oil standard an accident or was it a deliberate product of U.S. policy? Motives are difficult to determine and the U.S. Treasury has not claimed to tie the dollar to oil prices. The ultimate effect of the end of the oil standard is difficult to predict, but one should not understate its importance.

Many have written that the world was on an “Oil Standard” and for the period of 1985 to 2004 you could exchange your dollars for an average $30 barrel of oil. Then something changed and oil broke out of that range to over $60 today. Imagine if you are OPEC. You suddenly lost half of the value of your dollar denominated assets in a year. (You can say oil went up to $60 or you can say the dollar only bought half as much.) We can look back at the changes that took place in this country, financially, since 1971 when Nixon took us off the “Gold Standard”. The Energy Bulletin alludes to serious changes coming from the end of the “Oil Standard”. Back to Econbrowser, Hamilton asks the question:

…if ($15-30) is the downside risk that oil companies are contemplating, why don’t they hedge away the risk by selling more oil forward at the $64/barrel price that one can currently guarantee through the December 2010 futures contract?

That’s is exactly what Barrick (ABX) and Placer Dome (PDG) did when gold prices were in a 20 year bear market. With the collusion of the central banks and the bullion banks, these gold mining companies and others as well, sold futures on gold, ostensibly, to take away the mining risk, but it also kept the use of gold, as an inflationary signal, under wraps. The politicians didn’t want you to know that the dollar was losing 95% of its value. Now we have Barrick with losses on its hedges north of $3 Billion and Placer Dome with losses on its hedges of $1.5 Billion. Pray the oil companies don’t get this stupid! Carnival of the Capitalists energy gold standard oil standard derivatives

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