June 16, 2003
by Irwin Stelzer
It has been skillfully reengineered, all the new parts are in place, and it is now on the launching pad. All it needs for a blazing lift-off is some cheaper fuel. That is the current situation of the U.S. economy.
The tax cut is about to put billions of dollars into the hands of consumers. Homeowners continue to augment their purchasing power by swapping higher-interest mortgages for lower-interest ones. Four of the twelve Federal Reserve districts report improving conditions, and none say that their economies are deteriorating. The weaker dollar has given exporters a renewed lease on life. Profits and share prices are showing some strength. Despite some remaining signs of weakness, the general mood is far less gloomy than it has been.
But there may be a spanner in the works: oil prices remain stubbornly high. Lower prices of this key commodity would help put the economy back into high orbit, improving the jobs market and laying to rest fears of deflation. But prices seem headed in the opposite direction, with U.S. crude in the $32 range—well above what experts were predicting when the Iraqi war was won and Iraq’s oil fields were found to be intact.
Members of the OPEC cartel of oil-producing countries, meeting last week in Qatar, were among those surprised at the fact that prices remain at or above their target range. So instead of being faced with the necessity of shoring up prices by cutting production, they were able to keep output at about one million barrels per day above its notional ceiling of 25.4 million barrels, subject to review at another meeting scheduled for July 31, a mere two months from now. The shortening of the usual six-month period between meetings shows just how difficult even these industry insiders find it to judge when Iraq will rev up production, and how it will choose to market its oil.
Optimistic estimates of the speed with which Iraq would be able to resume exports on a significant scale did not take account of the deterioration of the fields that were under-maintained by Saddam’s regime, the looting of oil field equipment during and after the war, interruptions in electric supplies, and the unwillingness of technicians to return to work until some mechanism for paying them could be established.
Thamir Ghadhban, Iraq’s interim oil minister, has told the press that he expects to be pumping some three million barrels a day by year-end, which is more than the country was producing before the onset of hostilities. That may be overly optimistic, but if he comes anywhere near meeting that target, OPEC will have to cut output to make room for Iraq, which it plans to readmit to the cartel when Iraq has an oil minister who has been appointed by “an internationally recognized government”.
A flood of Iraqi oil, sold outside the control of OPEC, is the cartel’s nightmare. Dr. Nimrod Raphaeli, senior analyst at the Middle East Media Research Institute, reports that the London-based Saudi daily, Al-Hayat, says, “Waves of fear from the future are rolling across OPEC.” Which might not be a bad thing. At last month’s by-invitation-only meeting of top-level industry and government officials, sponsored by Repsol YPF and Harvard University in Salamanca, one leading executive suggested that OPEC is contributing to the misery of the masses of people who live atop but very rarely benefit from the world’s oil reserves. Bijan Mossavar-Rahmani, president of Mondoil, broke a long-standing taboo by asking, “Is the OPEC-inspired nationalization model best for managing a country’s oil resources? Do OPEC’s collective policies result in the optimal mix of prices and production? What is the level of each country’s oil revenues, and where do these go? The answers to these questions are no, no, and no one will tell.”
But OPEC’s members are not prepared for a voluntary change in the way they do business. Just last week, Saudi Arabia scuttled a plan to allow a $15 billion infusion of private sector capital into its natural gas industry and the related chemical and water industries. The country’s oil minister, Ali Naimi, won his battle to protect the turf of state-owned Saudi-Aramco from trespass by international oil companies eager to regain a toehold in Middle East.
So OPEC will be around for a while, at least until production from new areas such as Russia increases. Indeed, if the new producing countries choose to cooperate with the cartel, as Mexico and other non-members have elected to do, OPEC may be a force to be reckoned with for many years. But its policies, and the continued absence of significant quantities of Iraqi oil from world markets, are not the only reasons that oil prices remain higher than was expected.
Despite OPEC’s willingness to keep its taps open, inventories remain at levels the industry deems too low for comfort. That may be what OPEC intends. Some experts are now saying that inventories are the key price-determining factor, and that so long as OPEC can keep its output sufficiently low to prevent consuming countries from replenishing inventories, it can maintain prices near current levels.
Moreover, the supply-demand equation in the oil industry is a lot more complicated than merely matching total output with total demand. Refinery capacity is in short supply, and not all types of oil are suitable for all refineries. Venezuela’s heavy crude is used by some, Saudi Arabian light crude by others. This lack of perfect substitutability of one crude oil for another contributed to problems in the U.S. industry when Venezuela was in turmoil and the crude type on which many refineries rely was unavailable.
All of this means that president Bush can’t safely look to lower oil prices to provide an additional stimulus to the economy in time for his reelection run. He must rely instead on his tax cuts and the Fed’s easy money policy to convert the recovery that seems already underway into the second term that eluded his father.
A version of this article appeared in London’s Sunday Times on June 15, 2003.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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