Tight balance between supply and demand can lead to high prices that cause both higher expenditures for consumers and higher incomes for producers. In economics, exhaustible resources generally follow the rule that the rate of growth must equal the rate of interest in order to reach industry equilibrium. However, due to the unpredictable character of future oil supply and demand conditions, oil prices do not generally follow this rule. Most of the time, it exhibits backwardation wherein future prices are lower than current ones. Future demand is hard to predict because it is difficult to foresee changes in energy technologies and it takes years for consumers to switch to other resources should prices go off the roof. On the other hand, investment is expensive and risky and it takes a while before production supply turns to high capacity. Oil prices also behave unexpectedly since the market is responsive to speculative pressures, operational constraints, and political conditions.
The Hurricane Katrina, by reducing gasoline supplies (which is chiefly derived from crude oil), became one dramatic factor that caused oil prices to skyrocket in 2005. The storm reduced oil production, transportation and refining capacity--it paralyzed major oil and gasoline pipelines that carried supplies down from the Gulf Mexico and took down offshore oil platforms. ...Show more