As anyone who drives an automobile has noticed that gas prices have spiked since the first of the year. A steady increase in the price of oil can be expected as supplies become more difficult to obtain due to both political concerns and the decline of easily obtained oil. But the recent soaring prices are greater than what this alone can explain. Popular theories include a dropping value of the dollar, speculation and market manipulation.
While its viscerally satisfying to blame oil company collusion, George Soros has been
testifying that the root cause is largely due to domestic fuel subsidies in China and India.
A lengthy excerpt from Morgan Stanley summarizes the situation:
A quarter of the world's gasoline consumption is subsidized, and, in terms of population, half of the world uses energy subsidies. This policy has created an important distortion, whereby rising oil prices have been effectively prevented from destroying oil demand. Subsidies have artificially raised inflation in the developed world (through artificially high oil prices) and suppressed inflation in the developing world (inflation would have been even higher in the absence of subsidies). As fiscal pressures mount, some countries will be forced to incrementally remove these subsidies. The net result will be an unwind of these distortions...
As the fuel consumption in these developing countries increases, the price is driven up, but the self-regulating force of inflation is negated by artificially suppressing domestic prices. This is costing both India and China a lot of currency and can not be maintained indefinitely. On the other hand, maintaining accelerated growth is necessary for political stability in China, so its hard to say which will give first.
In the mean time, developed countries will faces significant inflationary forces due to soaring energy costs. While painful, this might prove to have some long term positive benefits if it results in the adoption of a coherent US energy policy.