Part II:
Oil's Well ...
From the February 23, 2004, issue: Even at $35 a barrel, the economy will probably be fine.
by Irwin M. Stelzer
02/23/2004, Volume 009, Issue 23
URL:http://www.weeklystandard.com/Content/Public/Articles/000/000/003/741jvwlq.asp?pg=2
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OPEC members are famous for cheating on quotas when high prices make it attractive to do so. That's why production now exceeds quotas by 1 to 2 million barrels per day. So it is unlikely that all of the agreed cuts will be realized. But with inventories at a 29-year low, OPEC members are likely to keep output close enough to agreed levels to keep supplies tight.
Which brings us to the possibility that non-OPEC members will fill the gap--and inevitably to guesses as to how Russia, which now produces almost as much oil as Saudi Arabia, will behave.
No one knows for sure what Vladimir Putin's plans are, other than to make certain that his nation's oiligarchs don't become effective political rivals. But we do know that Russian oil is relatively expensive to produce, and that costly additions to infrastructure (ports, pipelines) are needed if output is to be increased significantly. Witness the fact that Russia's exports to China are now being shipped by train, pending the construction of a pipeline.
We know, too, that Russia's ability to keep its fiscal position in good shape is mightily helped by high oil prices, reducing its incentive to upset the OPEC applecart. So it doesn't seem wise to count on Russia to step up output sufficiently to ease price pressures on Western consumers.
Nor can we look to Iraq for relief on the supply side of the demand-supply equation. Not only is it proving more difficult than anticipated to get Iraqi oil back onto world markets in
significant amounts, but Iraq has made it clear that it plans to return to OPEC as the good cartelist it once was. Now that the Bush administration has abandoned plans to create a competitive private-sector oil industry in Iraq, and has opted instead for a state-owned monopoly of the sort that has brought stagnation and massive unemployment to other Arab producing countries, Iraqi cooperation with its fellow, state-owned producers is assured.
The longer-term supply picture may be even worse. Some experts now say that Saudi Arabia's ability to step up production has been overstated, and that its ability to dampen prices by turning on the spigot has declined sharply. Venezuela, its president a Castro-sound-alike who has decimated his country's industry by meddling in the management of the state-owned oil company, needs but is unlikely to attract massive foreign investment. Wood Mackenzie, the respected oil consultancy, says that the North Sea is no longer a profitable area in which to look for new oil. And analysts at the White House tell me that African sources can't be counted on as "reliable."
At the same time, the best guess is that demand for crude will not, as OPEC claims, fall sharply in the spring. True, the International Energy Agency is predicting such a drop. But it has been wrong before. China's omnivorous appetite for oil continues unabated: Demand grew by 33 percent last year, which surprised most forecasters. And the U.S. recovery should drive demand here up, although not by as much as before the first oil embargo, after which America partially delinked oil demand from economic growth.
Combine that picture of relatively constrained supply and growing demand, and it would seem imprudent in the extreme to assume that the end of the cold snap will bring a collapse in oil prices, especially since the summer driving season is not far off.
Fortunately, prices in the $33-$35 range do not inevitably mean a screeching halt to the recovery. Some analysts are guessing that $35 oil will cut about one-half of a percentage point off the GDP growth rate. Perhaps. But hardly a reason for gloom. With forecasts for growth ranging from 3.5 percent to 5 percent, we will probably never know what might have been had prices stayed within OPEC's stated range.
That doesn't mean we should be indifferent as between $25 and $35 oil--cheaper is obviously better, especially for the motorist-consumers who have been fueling the economic recovery. They are likely to face spikes in gasoline prices during the summer driving season, in good part because new environmental regulations will reduce refinery output and drive up the cost of converting crude oil into gasoline by mandating greater use of corn-based ethanol as a gasoline additive. No sense blaming OPEC for the pandering of Washington politicians to Iowa corn farmers.
But before we push the panic button, we should keep in mind that the recovery has been gathering strength even though oil prices have remained high; that more fuel-using industries rely on natural gas, the price of which has been falling, than on oil; that consumers continue to snap up gas-guzzling SUVs, suggesting that they feel they can afford higher prices for gasoline; and that there are powerful forces operating to keep the recovery rolling.
Fiscal policy is loose to the point of irresponsibility, as the president opts for guns, butter, tax cuts, prescription drugs, and Mars. Last week, Alan Greenspan used his semiannual report to Congress to reiterate his view that the absence of inflationary pressures allows the Fed to be "patient" before raising interest rates, adding relaxed monetary policy to the more-than-relaxed fiscal policy. Businesses that have delayed investments are loosening their purse strings as profits exceed expectations, and corporate demand for bank loans is rising for the first time in four years. Consumer confidence remains high and spending remains strong, driving retail sales in January to 5.8 percent above year-earlier levels. The service sector is growing at the fastest pace since we started keeping records in 1997, the manufacturing sector is also on the upswing, construction spending is at an all-time high, and the economy added at least 112,000 new jobs last month.
So America's real oil problem is not the price the cartel is currently able to extract. It is, instead, the threat to the continuity of Middle Eastern supplies from terrorists and fanatics who will be emboldened to create chaos in Saudi Arabia, Kuwait, and other countries if we fail to achieve our goals in Iraq.
Irwin M. Stelzer is a contributing editor to The Weekly Standard and director of economic policy studies at the Hudson Institute. |
