The Wall Street Journal on Oct. 6 had a front-page item titled, "Where has all the oil gone?"

Over the past four decades the oil price rose from $2 a barrel, in 1967, to $79.40 at the time of writing. Over the past year alone, the price of oil has risen 32 percent in U.S. dollar terms. Where will it go next?

In the past, the key determinates of the oil price were the relatively simple balance of supply and demand and of risks to that supply, particularly to oil produced in the Middle East.

We feel that, today, the equation is considerably more complex.

First, the normal supply-demand equation has been affected by the aspect of more widely distributed world demand and by the relatively inefficient use of oil by some countries that make up the new demand.

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Second, a plunging dollar can create a false picture of a rising price.

Third, there are two major perceived threats to the U.S. supply of refined oil: hurricanes in the Gulf of Mexico and a subtle new twist on the traditional "war risk" dynamic.

Finally, it appears that financial speculators are playing a larger role in oil, influencing its price.

With globalization, demand clearly has risen. But it has risen more than might have been expected. This has rendered obsolete many price-forecasting models.

That is because many of the new users of oil are less efficient than most users in the United States. For instance, as CNBC has reported, Chinese oil consumption is three times less efficient than in the United States.

As China imports increasing amounts of oil, this too has unexpectedly boosted forecasted demand.

In a recent CNBC interview, the legendary oilman T. Boone Pickens asserted that world oil supply appears to be flat at 85 million barrels a day. Current world demand of 88 million barrels, he felt, indicated a continued rise in the real, or inflation-adjusted, price of oil.

It is clear, though, that the U.S. economy has been in contraction for several months and is now headed for recession, perhaps a deep one.

America is still such an important actor in the world economy that a recession in the U.S. will cause a global slowdown.

Normally, this would indicate a decline oil demand and a falling price.

Besides the marginal price influence of supply and demand and of speculation, the fact that the U.S. dollar is plunging in value creates the false impression of a rising oil price (see chart No. 1).

Therefore, if the real price of oil were to fall as a result of a recession and falling demand, or on speculator sales, the dollar price could continue to rise.

In fact, the average price of oil in 1980-81 was $37.02 a barrel. Today, that same price is a staggering $89 in today's depreciated dollars, using the U.S. government's very conservative PCE inflation index.

Indeed, the 1980-81 high of $39.50 is equivalent to $95 in today's depreciated money (see chart No. 2 below).

A failure to acknowledge the real affects of the depreciated dollar can lead to some distorted conclusions.

As my colleague David Frazier very aptly points out, the forecasts of a U.S. consumer downturn based on a $70 oil price were wrong. Apparently, the pundits had forgotten the massive depreciation of the dollar.

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As such, it would not be until the pump price of gasoline reaches $4 per gallon that U.S. motorists will initiate meaningful cutbacks in consumption. However, going into a recession, this cutback point could trend downwards to, say, $3 a gallon.

In addition to the real influence of supply and demand and the price inflationary effects of a plunging dollar, there are two additional perceived threats to the supply of refined oil and gasoline.

The first is the threat of hurricane activity in the Gulf of Mexico. Two weeks ago, for instance, the threat of a relatively weak hurricane, even in the southwestern Caribbean, helped add $3 to the barrel price of oil.

The second major threat to the supply of oil is that roughly one third of world supplies pass through the militarily vulnerable Strait of Hormuz.

The Arab-Israeli problem is constantly named as the key to stability in the Middle East. Recent history, too, supports that view.

Having spent considerable time as an investment banker in the Middle East, I am no longer convinced of that argument and of the continued preeminent importance of the Arab-Israeli problem.

Today, I see what I term as the "revivalist march of Islam" as the essential issue regarding stability in the Middle East. It has pushed the Arab-Israeli problem, as serious as it is, to one side.

This new type of "war risk" in the Middle East is both far larger and potentially far more sudden in its overall financial impact than the risk of a flare-up of the "old" Arab-Israeli problem.

[Editor's Note:Special: Where Are Oil Prices Headed? Click Here.]

It now appears almost inevitable that nuclear weapons will be introduced into the Middle East. While the traditional conflict required the relatively slow and more easily seen deployment of ground forces, a potential nuclear conflict is faster and more far-reaching, geopolitically speaking.

As such, it should make the war risk premium comprise a higher proportion within the overall total price of oil.

War risk and its new potential dynamic have, in our view, increased in recent years. What proportion of the current oil price it now comprises is almost impossible to determine.

However, because of the increasingly "nuclear" flavor of the potential threat, the war risk element in the pricing equation is likely to be larger than it was in recent history.

In addition to the above factors, The Wall Street Journal article points out that oil traders fear that the United States could hit an inventory low by year-end. Demand has played a factor, but investment banks and other financial firms also play a role, the Journal asserted.

Financial players who have piled en masse into commodities trading in recent years have made oil markets more unpredictable, contends oil-and-gas trader Stephen Schork, who publishes the Schork Report on energy markets. Factors other than supply and demand now impact price, making price forecasting increasingly difficult.

It should make our readers, too, more than usually careful about placing bets on the price of oil.

Editor's note:
Special: Where Are Oil Prices Headed? Click Here.
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