The new fundamentals—global financial dynamics and new cost structures—are driving the momentum that pushed oil prices to a record high of $111.80 per barrel on March 17. While oil settled lower the following day, it is still ahead of what had been the previous inflation-adjusted record high of $103.59 set in April 1980, according to Cambridge Energy Research Associates (CERA), an IHS Inc. subsidiary.

CERA’s calculation of $103.59 is based on the April 1980 nominal average posted price of $39.50 per barrel for West Texas Intermediate, a monthly average price, as no oil futures market existed to provide a daily price at that time. Oil futures trading did not begin until 1983. In November, CERA used $99.04 as the 1980 highpoint, but the surge of inflation since then means the $99.04 should be inflation-adjusted up to $103.59.

“Oil has become the new gold, a financial asset in which investors seek refuge as inflation rises and the dollar weakens,” says Daniel Yergin, CERA chairman. “The credit crisis has been fueling the flight to oil and other commodities, and that will last until the dollar strengthens or the recession becomes more pronounced.”

Shortages of equipment and personnel are “dramatically raising the cost of developing an oil field,” says James Burkhard, CERA managing director, global oil group, citing the latest IHS/CERA Capital Cost Index, which shows a doubling of oilfield costs during the past three years.

“Adding to this pressure is increasingly heavy fiscal terms on oil investments in the form of higher taxes and greater state participation in oil projects. The net result is that much higher oil prices are needed to support development of new oil supplies.”

These financial and cost-structure dynamics are new in the sense that they were not strong forces in determining the price of oil in the 1990s and even earlier this decade, he says. The old fundamentals, such as the balance between demand and supply, still matter, but the new factors are the driving force behind the record highs.

“Today, the falling demand for dollars is just as important as the rising demand for oil in determining the oil price,” Yergin says. “However, when looking back to 1980, today’s high prices also have a ‘back to the future’ quality. Many similar elements that contributed to the rise in price from $70 last summer to over $100 today were also in play in 1980, such as high inflation, a rush by financial markets to invest in commodities (in 1980 at gold’s all-time high price) and tension between the U.S. and Iran.”

In April 1980, Middle Eastern tensions were exacerbated by the Iranian Revolution, a failed attempt to rescue American hostages held in Iran, threats by Iran to choke off supplies from the Persian Gulf and to set the Gulf’s waters ablaze with oil, and a suspension of Iranian oil exports to Japan. Just a few months later, war broke out between Iran and Iraq. In financial markets, surging inflation and gold prices were triple the level of just two years earlier.

“Today’s dynamics in the marketplace reveal oil’s increasingly cosmopolitan nature,” Burkhard says. “The price of oil reflects not just levels of demand and supply, but broader macroeconomic and geopolitical changes, such as the growing influence of Asia, the Middle East, Russia and the Caspian countries at a time of economic downturn in the U.S.”

Further weakening of the dollar, compounded by higher industry costs, could push the price of oil to new records, similar to the $120-plus level identified in CERA’s breakpoint scenario in 2006, Burkhard adds.

The biggest offset in the other direction would be a spread of the economic downturn beyond the U.S., weakening demand and strengthening the dollar against other currencies, reversing the upward surge in oil prices.

“There are different indices and methods that can be used to adjust prices to inflation,” Burkhard says. “These methods can result in prices that are lower or higher than our $103.59-per-barrel calculation. However, we believe that using an annual average inflation rate, with 2008 estimates based on recent trends in the U.S. consumer price index, provides the best basis for comparison between 1980 and 2008.”