Since the 1970s, changes in global oil supply have had a major impact on our economy. Gasoline is an inelastic good, which means demand does not change very significantly when prices move. For example, if prices rise by 20 percent demand would typically fall only two percent.
This explains why wars in the Middle East, when there is a cutoff of oil supply, can have a significant impact on prices. Likewise in our country, when there is an outage in a large refinery, that too can have a major impact on gasoline prices.
When looking at the major oil suppliers in the world, much of it comes from very volatile regions. Middle Eastern countries, Russia, Venezuela and Nigeria all have unstable situations, which can disrupt oil supply.
Despite these geopolitical problems, the price of oil and gasoline have not changed too significantly the past several years. What is happening is that oil production is increasing in several countries. This added production is helping to serve as a buffer for potential outages in the more volatile regions of the world.
Our own country has been the leader in increased oil production. This has been due to the development of hydraulic fracturing, commonly known as fracking. The two states, which have seen the bulk of the increase, are North Dakota and Texas. In addition Canada, with its vast oil sands reserves, is seeing an increase in oil output.
In the Middle East, Iraq is finally starting to see a major increase in oil production. Its oil production surged to its highest level in the past 30 years last month. Iraq has some of the largest oil reserves in the world, so it definitely has the potential to be a more significant oil producer. Mexico has seen its oil production fall during the past decade. However,
Mexico has significant oil reserves, and allowing foreign investment should reverse that decline, and allow for Mexico to become a major oil producer once again. Increased oil production does bring tradeoffs. Many in the environmental community are opposed to fracking. Even in our area, we have the controversy of oil production in the Baldwin Hills. Generally speaking most oil production in this country is from more desolate areas, and not urban regions like we have here.
On the plus side increased oil production brings lower prices for consumers. Also, lower natural gas prices have reduced our demand for coal, which is a much dirtier fuel. In the geopolitical area, lower oil prices will hurt a major oil producer, such as Russia.
Recently we have seen gasoline prices in our area climb back towards $4 per gallon. This is a normal seasonal occurrence, as refiners start to switch over to a more costly summer blend to meet environmental standards. We should expect prices at the pump to stabilize near current levels barring any unusual developments.
While plenty of people have concerns about our reliance on fossil fuels, a switch to alternative energy will be a long and gradual process. In the meantime, increased oil production will help to lessen the chances of oil price shocks that have hurt our economy in the past.
More stable energy prices would also be a positive for financial markets. The stock market has typically sold off during periods of oil price spikes. We live in a volatile world, which means there will be disruptions in oil supply in the future. However, with greater production those curtailments should not be as severe.
Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.
