December 19, 2005
by Irwin Stelzer
If the Federal Reserve Board's monetary policy gurus have any doubt that "possible increases in resource utilization … have the potential to add to inflation pressures", as they said in last week's statement accompanying their 13th consecutive increase in interest rates, they need look no further than Shell Oil's announcement the following day.
The new consensus that crude oil prices will stay at or above $50 per barrel has had several consequences. Like its oil-industry competitors, Shell has upped its exploration and development expenditures, in its case by 27% to $19 billion. Kuwait has decided to draw on Western expertise to help it develop its untapped reserves, which look a lot more attractive at $50 than they did at $10. Other oil companies are scrambling for drilling rigs, labor and supplies.
The expectation that oil prices will remain high reflects the continued pressure that economic growth in America, India, and China is putting on oil supplies. Demand is also pressing on the supply of natural gas in many countries. In America, cold weather is driving demand and prices to levels unimagined when natural gas became the fuel of choice for power generators, many of whom are ruing that decision. In Britain, rising demand and monopoly constraints on supplies from the continent are having the same effect on prices. And Western Europe will face a difficult winter if a dispute between Russia and Ukraine, through which Russian natural gas passes en route to Germany and elsewhere, is not resolved.
Electricity shortages also threaten, or at least are seen by policy makers and large users as likely to occur before the decade is out. So nuclear power is once again being considered as a solution to the problem of keeping the factories running without increasing carbon emissions. And much of the political opposition to wind farms from all except the hard core NIMBY crowd seems to be dissipating, clearing the way for increased production of electricity from wind.
But the willingness of investors to come up with the money needed to augment energy supplies cannot alone solve the supply problem, at least not soon. It seems that there is a shortage of many of the resources needed to find and to construct new sources of energy.
Drilling rigs are in short supply, as are trained oil-field workers. Which is why fully one-fourth of the $4 billion increase in Shell's outlays will go to cover the higher prices of the labor and supplies it needs to punch holes in the deserts and ocean beds that contain the new reserves it so badly needs. That's just what the Fed has in mind when it worries that resource constraints might result in an inflation-inducing bidding war for supplies and labor.
The situation in the wind business is no different. Promoters and operators of wind farms are finding that they simply cannot get the machines (windmills, to us lay folk) they need. In some instances, manufacturers are diverting supplies to the United States to take advantage of a new and attractive tax regime. In all instances, prices are rising and waiting times for delivery are lengthening.
Nuclear advocates, too, have to confront a shortage of resources, most notably the skilled technicians needed to build and operate these capital-intensive facilities. With no new nuclear plants built in the United States for decades, the engineers and other highly trained staff that build these facilities have drifted into other jobs. It will be no easy thing to reconstruct a workforce capable of building safe plants, once plans to start construction get the multiple approvals they need -- if they ever do.
The inability to expand energy supplies creates a political problem. The political and economic cycles are out of joint. Higher prices for energy will, eventually, call forth additional supplies and curtail consumption. But "eventually" is not good enough for politicians, who must do, or at least be seen to do, something now -- right away.
So we get counterproductive moves such an attempt by congress to appropriate "excess profits" from oil companies, with the inevitable adverse effect on incentives to find new reserves, while lavishing subsidies on uneconomic energy sources. And a new enthusiasm for nuclear power, but no interest in learning about its cost.
Meanwhile, the American economy seems to survive the waste created by politicians' renewed interest in energy, and their unwillingness to give markets the time needed to sort things out. Growth continues at an annual rate of something like 4%. The drop in gasoline prices to around $2 per gallon, from a high of $3, has increased both consumer confidence and the level of cheer in America's boardrooms. A survey by TEC International, the "world's largest organization of CEOs" of small and mid-sized companies, shows that "On average, a majority of CEOs expect to see increased sales revenues, profits, investments, and employee numbers" in the next twelve months.
More significant from the point of the Fed is the fact that more than half of the CEOs plan to raise prices next year. Those pundits who are expecting the current cycle of rate increases to end when Alan Greenspan exits the stage in January, might want to think again. It is true that short-term rates are now 3.25% above their low in 2004, and that the housing market is showing signs of cooling. But in real, inflation-adjusted terms, rates are still only a bit above 2%, which is below the long-term average, and not deemed likely to stifle growth. As the Fed watches Shell forced to pay more for labor and supplies, and hears that CEOs are once again thinking about raising product prices, it is not likely to abandon the Greenspan upward ratchet merely because it has a new chairman.
A version of this article appeared in the Sunday Times (London).
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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