What's Really Behind Oil's Run-up?:
Memorial Day, which marks the beginning of the summer driving season in the U.S., saw gas prices at nearly $4 a gallon all over the country--and even higher in states such as Florida. Globally, the picture looks more worrisome: Oil prices crossed a record $135 a barrel during the weekend of May 24-25, although by Tuesday prices had come down to $131.

What's behind these regular flare-ups in oil prices? What are the major economic and geopolitical factors at work? How does expensive oil affect the U.S. and world markets, and what can we expect over the coming months? Knowledge@Wharton discussed these questions and more with finance professor Jeremy Siegel, author of The Future for Investors, and management professor Witold Henisz.

An edited transcript of the conversation appears below.

Knowledge@Wharton: As we know, oil prices jumped to a record $135 a barrel during this past weekend. Do you think that they are near the top now? And if not, how much do you expect them to rise over the rest of the summer?

Jeremy Siegel: I think that I would be presumptuous to even theorize about whether we are near the top. I don't think that anyone really knows. It's my feeling that even OPEC [Organization of the Petroleum Exporting Countries] has basically lost control of the price of oil, and they're going flat out. By that I mean that they can push some more, but not easily. And, given the demands, it obviously could go much higher. I don't think anyone knows [how much]. I think that it's a guess.

Witold Henisz: I think that a guess and a lot of uncertainty are certainly accurate. There have been discussions recently of $200 a barrel for oil. The big uncertainties are: Is there more existing capacity in the OPEC nations, can they produce it and will any one country go off line? There is a lot of uncertainty in African countries and Latin American countries about whether they can maintain their production and expand it according to existing forecasts. We simply don't know the answer to that, and the traders are trading based on that uncertainty, generating the high price of oil today.

Knowledge@Wharton: A lot of people are not very sure about what the major factors are--economical and geopolitical--that are really driving the price of oil. Could you help by explaining that a little bit for our viewers?

Henisz: We're in a period of tight balance between existing supply and demand, which is generating a lot of uncertainty about the future path of both of those variables. I think the big uncertainties that we have to grapple with are how much more capacity does Saudi Arabia have and how much can they bring online in the short term? We simply don't know. They haven't revised their existing estimates of reserves for some years--and we simply don't know whether they are conservative estimates or whether they can be expanded. That is true in many countries throughout Africa and Latin America. We don't know what the future capacity and reserve levels are.

Siegel: Yes, and as I've mentioned, I don't think that there's an easy way to increase the supply or at least significant supply in the short run. A lot of it is economic. It's hard to blame speculators because we don't see a lot of inventory increasing in oil, which would be a sign that people are hoarding it at this point. [There is also] psychology [involved in] that everyone wants a piece of oil because they want to protect themselves against oil price increases. So, if I own some, at least I'll have something that will go up when the price of oil goes up. Well, of course, if everyone tries to do that, it's almost like "the sky is the limit." This is because I think that not everyone can protect themselves or completely immunize themselves against this oil increase, and that's what the upper threat is.

Henisz: The other side is the demand uncertainty. How much more will demand in China, India and other countries grow? The other side of the equation is also a lot of unknowns.

Knowledge@Wharton: Right. I saw that George Soros, the billionaire investor, was interviewed by one of the British papers over the weekend. He said that speculation was primarily responsible for the further rise in oil prices. But it sounds like you don't necessarily agree?

Siegel: There's a fine line between speculation and buying for an even more expensive future. I think that people realize how important it is to hold some oil producing assets in their portfolio. If everyone thinks like that--that will go up. It's not just speculators ... moving that up. This is a scarce resource that the world is using more and more rapidly. Peak oil is always in the air, and I think that is generating the increases.

Henisz: If you look at the probability that one country could go offline, driving a substantial increase in price is something that people are trading on the probability of. Is that speculation, or is that hedging? When Southwest Airlines hedges their future oil supply, they are lauded as being smart relative to the rest of the airline industry. That's not speculation, that's hedging. Back To News

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