Still many economists and business forecasters may want to believe that current hike of oil price was caused by temporary distortion of market, and high price will increase oil production, then eventually oil price will be stabilized. However, oil production seems to peak and gradually decrease in the near future. Although there are some counterarguments on this, but let's stick on the peak oil scenario.
My question is whether real price of oil will increase or decrease when oil production decreases. In other words, whether will increasing rate of oil price still be lower than inflation rate of other commodities (Apparently, inflation rate (CPI) does not explain energy price)? Nominal price of oil will easily increase along with production decrease. It will cause supply-pulled inflation, too. We can consider two different cases about inflation and oil price.
- Inflation rate will be greater than increasing rate of oil price. Then we can say that real price of oil will decrease. Although nominal price of oil increase, price of other commodities go up higher. Then we may feel that oil is relatively cheaper. Oil and other energy sources are basic inputs into production. When oil price increases, it may cause cascade of value addition. For example, 5% increase of oil price will signal timber producers to increase its product price by 8%. Then, it will signal furniture producers to increase it's product price by 10%. When market participants expect such basic input price to increase, they may over-react by charging more than actual increase of inputs. In conclusion, higher inflation will disguise "real" price of oil.
- Increasing rate of oil price is greater than inflation rate. Then real price of oil will increase. In this case, the market reacts to higher oil price and reduces oil use in its production. Technological progress may explain this situation.