It was not so long ago that oil touched $110 for the first time. Through the roof, people said. And what were people saying when oil hit $100? “Wow, it’s going through the roof!”

I was in Houston last fall, when the price of oil passed $90 for the first time. I was in the company of T. Boone Pickens, who said, “It’s going through the roof, isn’t it?” Then Mr. Pickens added, “We’ll see $100 oil before we ever see $80 oil again.”

Really, in the past six months or so, it has been roof after roof after roof. We had better find a good roofer and put him on retainer.

Political Correctness, the Declining Dollar and the Price of Oil

After all, how many roofs are there? Maybe we should change the way we talk about the rising price of oil. How about using the famous old expression of the late comedian Jackie Gleason? He would clench his fist and say to his wife, “You’re going to the moon, Alice.” On reflection, that might be politically incorrect. Let’s not joke about a guy smacking his wife into lunar orbit. Not funny these days.

Battered-Dollar Syndrome

Then again, is it politically correct for the Fed and U.S. Treasury to follow a “weak dollar” policy? A declining dollar hurts all Americans, and every dollar holder in the world. Call it “Battered-Dollar Syndrome.” A declining dollar works against long-term investment. The late economist Kurt Richebacher used to say, “A declining currency destroys capital.” Still, somebody must think it is OK to devalue the dollar, because that is one of the key drivers behind the rising price for oil.

Here is a chart (right) that has been making its way around the halls of Agora Financial, courtesy of my colleague Chris Mayer. The chart tracks the price of oil against the ever-increasing money supply since 2001. In other words, as the amount of “money” has been growing (M3 on the chart), the price of oil has been rising. According to this chart, about 87% of the move in the price of oil can be explained by the increase in money supply.

A long time ago (in statistics class), I learned that correlation is not the same thing as causation. This chart helps explain what is going on. But there is more to the tale of rising oil prices. The U.S. money supply is growing, along with two other major developments. First, the demand for oil is skyrocketing around the world. Second, the world’s oil industry has reached a plateau in overall output. New output cannot keep up with depletion from older oil fields.

“Plateau, Stagnation”

Just the other day, for example, Leonid Fedun, a vice president at the Russian oil company Lukoil, held an interview with the Financial Times. Fedun said that last year’s Russian oil production of about 10 million barrels per day was the highest he would see in his lifetime (he is 52). Fedun compared Russia to the North Sea and Mexico, where oil production is declining dramatically. Fedun said that “the period of intense oil production [growth] is over” in the oil-rich region of western Siberia, the location of much Russian output. As if to confirm Fedun’s comment, Russian energy minister Viktor Khristenko said last week, “The output level we have today is a plateau, stagnation.”

Yet every time you look at oil consumption figures from places like China and India, the numbers are rising. Demand is up. Output is flat. And as Houston oil investment banker Matt Simmons likes to say, “Supply does not know demand.”

Prices Don’t Lie

So here is what is happening. The world oil supply has become very tight. Demand is rising. The price for oil would ordinarily be going up to clear the market. But with all the “extra” money creation coming out of the U.S. Fed, oil prices are going up even faster (this is what the chart above shows). And I should add that just the expectation of loose money is also inflating the price of oil. There is probably $15-20 worth of “speculation premium” built into every barrel.

When it comes to oil, prices don’t lie. We just don’t always like what they say.

Until we meet again,

Byron King

Note: Byron King is a frequent contributor to the free e-letter Whiskey & Gunpowder. To receive daily insights into energy, oil, commodities and other natural resources sign up here!