My Comment: Yesterday, at my usual barbershop, there was a vigorous discussion between the person next to me and his barber about how it was Obama’s fault that gas prices were so high. When I asked how it was possible for him to so aggressively influence the price of oil, I was told that it was all over the news and that therefore it must be so.

I suggested there was another reason, to which I got the comment that everything else wrong today was Obama’s fault, so it was natural to believe he was responsible for gas prices.

Soon after, a new barber to the shop, with no customer to take care of, stopped in front of me and asked what I did. I said I was an economist and helped people grow their money so they could feel secure about their future. She showed real interest. So I gave a short explanation about energy traders across the globe who almost instantly respond to perceived changes in the supply of oil, and if they thought the supply was likely to suffer, were willing to bid up the price for future contracts. I used an analogy about the price of milk and the number of cows and suddenly she understood.

When I am forced to listen to the likes of Santorum, Romney and Gingrich, people who should know better and prablably do, tell their respective flocks that Obama is the one responsible for high oil prices, and, by the way, they would have no hesitancy about bombing Iran, that’s when I’m tempted to throw up.

By Jeffrey Jones at Draco Capital Management

I heard a great interview on Bloomberg with Stephen Schork the other day. He’s always the guy that gets the call when things get funky in the energy markets. I admire his perspectives, too, because they’re so heavily influenced by the supply and demand fundamentals of the market.

In any case, I’m sure you’ve noticed how much more you’re paying for gas now than you were back around Christmas. Prices are high right now because of Iran. It’s 100% political headline risk. If that situation over there stabilizes, you could see oil prices fall dramatically over a window of a month or two. Commodity prices can fall a lot faster than they can go up. This could be the kind of scenario where you’re paying $4.75/gallon in June but $3.50/gallon by August.

Mr. Schork made a really interesting observation about Iran and the game theory that links all these parties. Iran is revenue starved right now, and oil is their only shot. If they are slapped with an embargo, they know they’ll be able to sell their oil to China, who, it’s a reasonable bet, wouldn’t honor an embargo with Iran. The problem — and Iran knows this — is that China would be able to dictate the price in such an arrangement. Hopefully Iran wouldn’t feel as though they were backed into a corner in that kind of situation and respond… irrationally.

This is an oil shock. These things happen. I’ve written many times before that the long-term future is not a catastrophic runaway of prices like we were all fearing back in 2008, but rather a long, slow, steady march higher with periodic short-term shocks along the way.

When you price oil in Euros or Pounds Sterling, Brent Crude is already at a record high. Shocks like this happen from time to time.

My concern is economic. High oil prices don’t cause recessions, per se. But just about all the recessions in the last 50 years have been preceded by a spike in energy prices. There is a very high correlation between the two. It isn’t a strictly causal relationship, but it is almost a perfectly correlative one. The economy is so vulnerable right now that I’m not sure it can withstand sustained gas prices of $4+ per gallon. Normally, energy prices can’t kill the economy on their own, but this time they could be a final straw of sorts.

I’m optimistic, though. There’s still so much supply around the world and right now Canadian crude is trading about $40/barrel lower than the global price. Our extremely stable supply is part of the reason why gas prices here are $3.75/gallon and prices in Europe are $8/gallon — we have a much more stable supply and there’s a better infrastructure in place to get the crude to where it needs to be refined. This is also one of the reasons why gas in the middle of the country is generally less expensive than gas on the coasts. The closer one is to a refinery center, the easier and cheeper it is to get gasoline.

(The other big part is taxes, of course. Europe has generally higher taxes on gas than we do. Which is totally fine. The tax code is nothing if not a tool to shape social behavior. Personally, I’m an advocate for using gas taxes to force people to change the kinds of cars they buy and choose how to get around, assuming we want to do that sort of thing. Hitting people in their pocketbook is very effective.)

I think this is about as bad as it’ll get. The nationwide average could certainly get up another quarter to $4/gallon (or $5/gallon if you live in California or New York), but I think that would take a marked deterioration in the middle east. You’d probably need to see some sort of real military conflict between Iran and the U.S. or Israel and Iran.
The consensus in the energy community is that this is temporary. That’s not to say it will be better before the summer, but it’s important to keep in mind the true supply and demand dynamics of the crude oil market. There is plenty of supply north of $80/barrel and demand isn’t growing the way it used to, not with China slowing down and the developed nations getting more efficient.

In the short run, all it would take is some hints of stabilization with Iran and indication of a peaceful outcome, and Brent Crude oil could fall dramatically in a very short period of time.

In fact, I’d probably look at this dynamic through its corollary. The answer to the question, “how do I know when I should stop worrying about Iran?” is when you see oil prices plummet. That’ll be the green light.