High oil prices may not doom the thriving U.S. economy, but they are about to become a serious political problem
THE WEEKLY STANDARD
March 20, 2000
With the price of gasoline in some parts of the country headed towards $ 2 a gallon this summer, the hotel industry worried that such prices will deter Americans from piling into their SUVs for a family vacation, the airline industry hiking fares to cover the rising cost of jet fuel, and truckers parading their 18-wheelers through Washington in protest, oil prices are back atop the political agenda.
It is not only the current run-up in prices, however, that accounts for this interest. There is something about the oil industry that has always attracted the attention of policymakers, both in consuming and in producing nations. On the consumer side of the pump, there is concern with security of supply and price spikes; on the producing side, oil is often the principal source of a nation's revenues and assumes mystical significance. In Arab countries, oil is "the blood of the earth"; in Mexico, it is seen as part of a nation's patrimonio, to be treated differently from other goods offered on world markets, and deserving of special consideration when public policy is made. Which is why the worldwide trend toward privatization of state-owned industries has more or less bypassed the oil producing countries.
These countries have lately gotten their act together. OPEC, the cartel formed by most of the oil exporting countries, is once again seen to be in control of world oil prices, its musings about production levels the stuff of headlines and of memoranda at the Fed. For two reasons.
First, the trebling of oil prices that has been engineered by OPEC comes at a time when the Fed is nervous about inflationary pressures from other sources. The labor market, a Greenspan-watched sector of the economy, is tight. Just about everyone who wants to work has work, and the pool of couch potatoes who might be lured into the labor market has been drained. Were it not for immigrants, many of them illegals -- Mexico being more willing to ship labor to us than it is to ship oil -- wage pressures would undoubtedly already have surfaced.
In this economic context, high oil prices become more of a threat than they would be were the economy growing more slowly and the labor supply more ample. It is certainly true that we are less dependent than ever on oil to keep our economy growing: The energy that drives the American economy is now more IQ and entrepreneurship than fossil fuels. But soaring oil prices nevertheless are unwelcome, especially to politicians in an election year. Voters will become increasingly unhappy as they realize that their troubles have been created by two countries that depend on America for their survival, and a third that depends on us for its economic viability.
As recently as late 1998, crude oil was selling for about $ 10 per barrel, one-third of its current level. Even that price was sustained by monopoly elements: Knowledgeable insiders tell me that in the Middle East new oil can be discovered, produced, and sold profitably at under $ 5 per barrel. No matter: The oil producers, desperate for revenues to support the lifestyles of their royal families and the welfare states that keep their masses from mutiny, want more.
Their problem was the classic cartel weakness that economics textbooks teach us: An agreement to curtail production so as to drive up prices might prove ineffective, as non-members of the cartel fill any supply gap. Most notable was the American market, easily accessible to non-member Mexico, which might try to increase its market share if the Venezuelans, Saudis, and Kuwaitis held back production. Enter Luis Tellez, the M.I.T.-trained economist who serves as secretary of energy in Mexico's government, and who specializes in delivering moving speeches about the virtues of free markets.
By promising to go along with any output cuts that OPEC might agree upon, Tellez emboldened Venezuela, Saudi Arabia, and Kuwait to initiate sharp cutbacks in production -- sharp enough to draw the world's inventories of oil down to record low levels, to triple the price of crude oil, and to send our secretary of energy, Bill Richardson, scurrying to the Middle East to beg for mercy.
The indignity should be obvious. Were it not for American military might, Saudi Arabia and Kuwait would both now be southern provinces of Saddam Hussein's Iraq, with the lucky members of the royal families in exile, and the unlucky ones dangling from some gallows in Baghdad. And were it not for America's willingness to give Mexico free access to our markets pursuant to NAFTA, and to allow a virtually unimpeded flow of immigrants from Mexico to find work here and send remittances home, the Mexican economy would be a shambles.
But gratitude in these matters is in as short supply as oil. So Richardson, who sees his chances for a vice-presidential selection by his buddy Al Gore sinking as the price of gasoline rises, has been reduced to trying to persuade the producing countries that if they continue on their present course our economy might lapse into recession, threatening the value of their massive investments here. That argument is not very persuasive. Sheikh Ahmed Zaki Yamani, Saudi Arabia's former oil minister and now chairman of the Center for Global Energy Studies, estimates that $ 30 a barrel cuts the U.S. growth rate by 0.8 percent, hardly a disaster for our fast-growing economy.
The OPEC countries meet later this month, and as best one can tell from the rumor mill, the Saudis will argue for a slight increase in production, with the Libyans, Iranians, and Algerians fighting to keep output at its current restricted level. Iran's oil minister, Bijan Namdar Zanganeh, has told the press that "market fundamentals and reality do not point to supply shortages; . . . there is no crude shortfall." No matter. Even if the Saudis prevail, the contemplated boost in production will not be sufficient to bring prices down, and may not even prevent further price increases. The Saudis are likely to propose a 1.2 million barrel per day increase in the cartel's output, far short of the 2 million barrels that traders say would be necessary to make a dent in current prices.
So what is America to do? In the short run we could make it clear to Saudi Arabia and Kuwait that the American umbrella might be furled if they continue to restrict output. It is true, of course, that were either of those countries to fall under the direct or indirect control of Saddam, we would have a problem. But nothing like the problem that the Saudi and Kuwaiti royal families would have. We would have to pay more for oil; they would be out of power or dead.
We could also explain to Mexico that our continued willingness to keep our borders open to their goods and their unemployed is contingent on their willingness to ship oil to us in sufficient amounts to bring oil prices down. No oil, no Mexican-assembled cars or T-shirts. Sure, we would be giving up the benefits of cheap imports and an important source of labor. But again, our great big prosperous economy can afford that hit more than Mexico can afford to get along without our markets.
In the longer term, we have to reduce our vulnerability to extortion. Which brings us to the Strategic Petroleum Reserve. Jim Schlesinger, at various times secretary of energy and secretary of defense, recently pointed out in the Washington Post that because we now import much more oil than we did 15 years ago, the oil in the reserve has dropped from the equivalent of 100 days supply to only 55 days, not enough in his view to shave much off current prices, were it sold. Besides, we are unable to come up with a coherent policy for the use of the reserve. Schlesinger argues that it is there to cope with "a supply cutoff," not price swings. And Bill Richardson, in a display of economic illiteracy astonishing even for an energy policymaker, says, "We are not going to use it. We can only release from the SPR when there are real supply emergencies. This is a price problem." The notion that the supply of a good is a separate issue from its price will be news to writers of elementary economics texts.
So much for the strategic reserve. We have assured the OPEC cartel that we will not use it to dampen price spikes; indeed, we will not use it until all of our oil supplies are exhausted -- which means we will never use it. Which leaves us with two alternatives.
We could use our vulnerability to price extortion as an excuse to adopt the uneconomic conservation and fuel-subsidy programs advocated by various environmental and special interest groups. With Al Gore in the White House, pondering how to eliminate the internal combustion engine and to cool the globe, such schemes will have a receptive audience.
So our first chore will be to separate the wheat from the chaff, or the sensible plans from the ethanol. Our second chore will be to reexamine the case for a tariff on oil imports. Not a protective tariff in the ordinary sense of that term, but an economic tariff that is designed to make certain that the price paid by consumers of oil products includes all of the external costs associated with the use of imported oil. Most notable among those external costs are the risks associated with relying on imports from countries that vary between the unstable and the overtly hostile.
Some of those risks are known to individual consumers when, for example, they install oil heating, and should be borne by them. But there are other costs that may not be fully reflected in the price paid for oil by consumers, most notably the macroeconomic risks necessarily associated with price spikes and supply cut-offs that seem to accompany reliance on imported oil. If users of oil are subjecting the American economy to periodic bouts of inflation and recession, they should bear the cost of those fluctuations. An oil tariff would force them to do so.
It would also have two salutary effects. By raising the cost and price of imports, it would reduce the use of imported oil, with no negative effect on economic growth if the proceeds are recycled to taxpayers through parallel reductions in other taxes. And a tariff would provide funds to allow us to diversify our sources of supply by drawing on oil from countries that eschew OPEC discipline, and would for that reason be exempt from the tariff.
Is this a perfect solution? No. But it is the best that comes to mind. Our strategic petroleum reserve is too small and the policy for its use too incoherent for it to be of much use. Begging producers for mercy is useless and demeaning. Adopting the more crackpot schemes beloved by Al Gore would be phenomenally expensive. So reducing our vulnerability to OPEC rapacity by asking consumers to bear all of the costs they impose on society by using imported oil seems the best available alternative.