Jul. 2--BY FAHMI ABU-DAYEH

AMMAN -- When oil prices were approaching $50 a barrel and going on to $147, The Economist published an article titled "Oil: How to Avoid the Next Shock." It is not possible to avoid a shock when it is coming, but coping with it is more likely, and that is the title that I have chosen for the article.

During deep economic crises, an academic usually tries to reflect on whether what is happening today has any relevance on what he has seen in the past in theory books. It didn't take me long to find out that it has.

Each time I see an oil crisis looming on the horizon, I find myself saying: "God bless your soul professor Homer Paul Balabanis (1897 -- 1991) and may you rest in peace." You were the first one to sound the alarm on the impact oil will have on our future in the 21st century.

Nowadays, political leaders are calling the shots when it comes to picking the fair price, and that depends whether they are producers or consumers. President Dmitry Medvedev, a producer, said during the Petersburg International Economic Forum (June 4-6, 2009): "As the President of Russia I want the price of oil at $150/barrel but I will settle between $75 and $80." Others see it at $100. Hugo Chavez, the president of Venezuela, sees it at $500/barrel. The rationale for choosing a price this way is not really known, because there isn't any. But those are the politicians who talk about money.

An economist like Homer didn't care about money. He only thought of it as a medium of exchange. He cared about the welfare of individuals all over the globe, and from that concept came his idea about the fair value of oil.

If Homer was with us, he would have died (second time around) laughing hearing those leaders giving us directives on the fair price of oil and at what level it should be. Homer would have given them the same lecture on his theory of the fair value of oil that he gave us long time ago, which went like this.

"There is no such thing as fair price. In any market, price is the result of interaction between supply and demand and the resulting price from that does not have to be fair. However, the fair value of oil happens when oil producing countries are fairly compensated for their oil by the oil-consuming countries."

Homer said that 25 B.C. (25 years before Chavez became president) and long before we had NYMEX (New York Mercantile Exchange). Oil and gas are traded minute by minute on the NYMEX exchange as a commodity for speculation. Each contract trades in units of 1,000 barrels, and the delivery point is Cushing, Oklahoma/ USA.

The funny thing I have never seen one single barrel of oil delivered to this village (population 9,000) since NYMEX started trading in 1983. So, where does all that oil go? Practically nowhere, because there is no oil to go around except what is traded on paper on the exchange floor.

In addition to the standard contract of oil, there is the NYMEX crude oil futures contract which is designed for investment portfolios (speculation). It is the equivalent of 500 barrels of crude. The contract is available for trading and clears through NYMEX clearing house.

How can we forget the chaos that NYMEX caused in 2008, when oil price reached $147/barrel in July of that year? During that period the volume of financial contracts traded reached one billion barrels while average daily production of oil during 2008 was 88 million barrels/day. What was created on paper was more than 100 times the actual production.

It would not take more than a student in Econ 101 to figure out what the price would be if the quantity demanded was 100 times the quantity supplied.