From the April 27, 2008 Sunday Times (London)
April 28, 2008
by Irwin Stelzer
There are more misunderstandings about the oil market than perhaps any other. In America, drivers are fuming and politicians are demanding explanations because petrol has hit about $3.50 a gallon. That’s 47p a litre, less than half the 105p-115p being paid by British motorists. So “high” in Cambridge, Massachusetts, and Oxford, Mississippi, is “low” in similarly named cities in Britain.
But assume that prices are “high”, which indeed they are by historic standards. We are mistaken when we think these “high” prices are causing inflation. High oil prices can force consumers to spend more on petrol and heating oil, at the expense of other purchases. Ask any suffering restaurateur or clothes retailer if you doubt that. But high oil prices can’t trigger a rise in the general price level – inflation – unless someone pumps money into the economy so that, to use an oldie but goodie from the economists’ lexicon, there is more money chasing the same amount of goods. If you want something to blame for inflation, don’t look at oil prices, look at the billions the Federal Reserve’s monetary policy gurus and their confederates at the US Treasury are pouring into the economic system.
Another myth: we are running out of oil. According to WorldPublic Opinion.org, “majorities in 15 of the 16 nations surveyed around the world think that oil is running out . . . only 22% on average believe that ‘enough oil will be found so that it can remain a primary source of energy for the foreseeable future’ ”. Those majorities who think we are running out of oil include 85% of the British and 76% of the American citizens polled. Luckily, they are wrong.
Production of oil is being constrained by several forces, none of them due to God’s failure to put enough of the black gold under our feet. Several countries that are important sources of supply are in political turmoil, and unable to bring to market the oil they are capable of producing. Think Nigeria, where security problems have shut down about 20% of the nation’s capacity of 2.5m barrels a day and discouraged new investment, and Iraq, where political paralysis and terrorists have kept production at less than half its potential.
Other countries will not develop the reserves of oil known to lie under their territories.
Russia has made it clear that foreigners who invest in its oil industry might be playing a game with Vladimir Putin known as heads I win, tails you lose. Find nothing and you lose your money; find substantial reserves and the state squeezes you until your shareholders’ pips squeak. Only companies at least 51% owned by Russians – read FOPs, Friends of Putin – are allowed to look for oil in the new, difficult areas in which it is to be found. Little surprise that oil output dropped in the first quarter of this year.
Mexico’s president, Felipe Calderon, wants to revive Petroleos de Mexico (Pemex), the world’s third-largest oil producer, by contracting with foreign companies to introduce modern methods of extracting more from existing fields and finding new ones. But legislation is stalled by left-wingers who have seized and are sleeping at podiums in both houses of congress.
Saudi Arabia’s royal family has announced that it will not expand capacity. Abdallah Jum’ah, chief executive of the kingdom’s oil company, said high prices didn’t mean the world needs more oil because such market signals were “imperfect”, and energy minister Ali al-Naimi has announced that there are no plans to embark on a new round of expansion. The oil is there, but with current production yielding about $120 a barrel, there is no incentive to find more, especially since new production might drive down prices as demand from the slowing American economy falls.
Venezuela’s oil industry can only be described as a mess. President Hugo Chavez’s cronies are inadequate substitutes for the technicians they have replaced, so production is falling, while foreign investors are reluctant to trust hundreds of millions in exploration dollars to a regime that treats contracts as the first step in a negotiation.
In America, Congress alternates between calls for “energy independence” and refusals to allow drilling in what it considers environmentally sensitive areas in Alaska and offshore California and Florida.
There’s more, but you get the idea. There is a lot of oil out there to be found and produced, not even including the vast reserves in Canada’s tar sands. We might have reached the age of peak panic about oil supplies, but not of peak oil.
One thing we think we know about the oil business is correct. High oil prices and the greenhouse gasses produced by using oil have important geopolitical consequences. These $100+ prices have led to a massive flow of wealth, and hence power, from consuming to producing countries. If oil were still $20 or even $40 a barrel Russia would not have the wherewithal to revert to its bullying foreign policy, and America’s banks would not be going hats-in-hand to Arab capitals in search of new capital. If petrol prices had not closed in on $4 a gallon in America, thousands of Chelsea tractors and small trucks would not be sitting, unsold and unloved, on dealers’ lots. If oil had not gone above $100 a barrel, the current enthusiasm for super-expensive nuclear power would not have reached fever pitch.
And if oil did not produce greenhouse gases when propelling cars and heating homes, there would be no huge subsidies for ethanol production, acreage would not be diverted from growing food to growing fuel, and the current run-up in food prices would be less steep.
So oil indeed matters. But not in the ways we most often think.
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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