President’s Policies Feed Oil Price Fire

History tells us that while Rome burned, Nero fiddled.  By contrast, as the world’s oil markets go up in flames, the Obama administration seems determined to throw more wood on the fire.

No one can seriously dispute that oil is critical to our economy.  And high sustained oil prices could bring the U.S.’s nascent economic recovery to a screeching halt.  So the question is, what affects oil prices and can U.S. policies contribute to lowering prices to sustain economic growth?

A number of factors affect the price of oil but the primary one is good old supply and demand.  If demand is high and supply is tight, prices rise, and that is a condition of the present market.  While the U.S. has seen a growth in demand in the past year as its economy has begun to rebound, the real growth is in developing countries, especially China, which are demanding increasing amounts of oil to fuel their sustained, high annual growth rates.  Demand is definitely growing faster than supply.

A second factor affecting oil prices is uncertainty in the marketplace.  Oil is bought and sold months before it is expected to be delivered.  If traders are uncertain that the oil will be there to be delivered when it is required, then they bid up the price to lock in their share of supply. Certainly, the protests and street battles that are taking place in the Middle East where so much of the world’s oil either originates and/or must transit through, has added to the uncertainty.  A few years ago, when the Middle East seemed more stable, actual or perceived political problems in oil exporting countries in Africa and South America – as well as the  conflict in Iraq and tensions between Iran and the U.S., were the main sources of uncertainty in the market.  They had the same effect as present tensions, uncertainty concerning future supply drove up the price of oil.

A third factor affecting the price of oil is the relative strength or weakness of the dollar.  Currently the dollar is weak.  And with the U.S.’s deficit, and the anticipated lack of political will to tackle it and the long-term debt, the dollar is likely to remain weak for some time to come.  Whatever the other positive or negative effects of a weak dollar, since oil is traded on the market in dollars, a weak dollar means oil producers require more of them for each barrel of oil which means buyers must scramble in the debt or currency markets to come up with dollars.  Though dollars are in demand, printing and deficits continue keeping the dollar weak (which is leading some countries to suggest switching from the dollar as the reserve currency).

U.S. policies can affect all three factors.  Should high prices continue and dampen or even contribute to reversing the modest economic growth the U.S. is experiencing, then, as happened just two short years ago, U.S. demand for oil would fall and to the degree that U.S. demand places pressure on the oil market, prices should fall – modestly, most likely, since developing countries’ growth would likely continue.  Continued or expanded instability in the Middle East, and/or direct action to intervene, by the U.S. alone or in concert with allies, could also affect the supply of oil positively or negatively depending upon the results.

The third factor, I won’t address since the ins and outs of fiscal policy and the virtues of strong versus weak dollars is beyond my expertise, other than to say, Federal policies and actions by the Federal Reserve could act to reduce or increase the price of oil.

The second factor is where I want to focus my attention.  In an article released yesterday, Joe Barton points out something I have long argued, the U.S.’s pain at the pump is in no small part its own making.  For years we have forgone oil exploration and production in the areas of the U.S. most likely to contain our largest remaining conventional reserves.  We’ve placed the Arctic National Wildlife Refuge and its billions of barrels of oil off limits when even Jimmy Carter thought we should be able to drill responsibly there.  We had a moratorium on drilling on the U.S. outer continental shelf, despite the fact that drilling off our coasts – even with the Deepwater Horizon disaster – is far more environmentally friendly (and economically secure) than increasingly importing oil.  This moratorium came off just before President Obama ascended to office and in the aftermath of the Horizon blowout, was reinstituted (illegally as it turns out) and now basically remains in place in a de facto fashion if not de jure.

The roadblocks the Obama administration has raised – one log they are throwing on the fire — against off-shore drilling and the limits it has maintained on drilling in Alaska and on public lands in the West has resulted in lost jobs, lost revenue to the treasury, and contributed to a decline in oil production of over 300,000 barrels a day.

President Obama is certainly correct, as was President Bush before him, that drilling in the U.S. would not make us energy independent.  However, it would reduce our dependence and every time the price of oil increases dramatically we have the same old debate with those fighting increased domestic production (when environmental arguments fail) falling back on two  arguments: First, that “even if we began drilling now, it would be a decade before the oil was flowing;” and second, that increased domestic supplies would only reduce prices by some small amount – the amount changes but it is always too small to make a big difference in price.

Concerning the former argument, In fact, it may take a decade to tap some of the oil in the most difficult regions but we could see oil flow from other areas in two to five years.  More to the point, if we had begun drilling in ANWR  in 1980 when it was expanded and Carter admonished Congress to figure out a way to allow drilling, we would have been pumping oil for 20 years now.  And if we had started drilling when George H.W. Bush was President in 1990 during the first Gulf War, even if it took the full ten years, we still would have been receiving oil hundreds of thousands to a million barrels of oil a day from ANWR for a full decade by now.   The point is to start now so the same arguments aren’t repeated and used to prevent drilling five years or a decade from now when prices spike again.  If not now, when, if not here where?

The second half of the argument underappreciates the inordinate effect that new oil supplies entering the world market from the U.S. would have.  Though an additional 2 million barrels a day from ANWR and the OCS would only be a drop in the bucket of world oil demand, because it is coming from the stable U.S. it would reduce the uncertainty that impacts global oil prices.  Just holding the lease sales and granting the permits to drill, long before any oil flows, would tell the market that medium and long-term help is on the way.  This would have an outsized moderating influence on high prices and the volatility in the market – beyond that the simple addition of the oil would have. In commodities markets, where oil comes from counts.

A second log that President Obama is throwing on the oil price fire is his stubborn insistence that the U.S. enact restrictions on CO2 emissions.  Regardless of what the U.S. does, greenhouse gas emissions will continue to rise, yet President Obama has threatened to veto any bill which restricts the EPA’s ability to limit greenhouse gas emissions.  Since fossil fuel use is the primary (though hardly the only) source of greenhouse gas emissions, restricting carbon means raising the price of fossil fuels – including oil.  Whether it’s through regulations, a cap-and-tax scheme or directly through a tax on fossil fuel use, raising the price of oil (among other fossil fuels) is not what the economy needs or what consumers are clamoring for.

Ironically, the administration’s carbon restrictions would act to lower the price of oil on the world market since demand in the U.S. would decline.  Unfortunately, neither American consumers nor workers would benefit from the lower prices – remember the tax is imposed on them to restrain their oil use. Lower world oil prices combined with rising prices in the U.S. will encourage more companies to move overseas to places where energy prices are lower.

This is  hardly a recipe for economic growth and increased employment in the U.S.

Comments (8)

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  1. catherine says:

    You can add to that the Saudi goverment opening fire on protestors today. Stocks are diving, oil jumped and gold is rising, yet again:

  2. Simon says:

    Great post Dr. Burnett.

    An additional barrier to growth would be the extensive administrative cost to enforce these top-down regulations. An increase in continuous supply will increase certainty within the market, as the demand is relatively price inelastic (at this point). Knee jerk reactions in any policy field will create large uncertainty, despite any contradictory rhetoric from the administration.

    As far as tax policy, a cap and trade is a relatively non-neutral policy that widely interferes with the market. In addition to large administrative cost, this will decrease vertical equity on the ability-to-pay principle and have large impact on companies that do well. Thus, these policies are not only relatively unfair, but potentially very costly.

  3. Alexis says:

    It’s becoming clear that now is the time to encourage domestic oil production.

  4. Jean says:

    How does domestic production help domestic oil prices? It is my understanding that even if there was increased domestic production, events such as those in the middle east would still trigger the global uncertainty that would cause oil prices to spike.

    It is my understanding, and correct me if I am wrong, that because oil is traded on a global market, it is those global market prices that determine domestic prices at the gas pump, so an increase in domestic production would only help domestic prices insofar as it would cause the GLOBAL price of oil to decline significantly, which seems extremely unlikely, and at best, would only be realized in several years, possibly decades from now.

    I am also interested in seeing any figures you could cite which correlate domestic emissions regulations with the global price at which oil is traded.

    Interesting post.

  5. H. Sterling Burnett says:

    Jean, I appreaciate your question but I’m a little puzzled by it since the first question, I believe is answered in the original post. You are quite correct that oil is priced in the world market and problems anywhere would cause spikes but an additonal 2 million barrels (or more) a day brought to the market that could be counted upon — not subject to disruption due to war or geopolitical blackmail — would reduce uncertainty. Any spikes that occur from uncertainty elsewhere would start from a lower base price. Prices rise and fall not just based on actual supply and demand conditions but from anticipated conditions — this would improve the outlook for anticipated supply. It use to be a regular mantra that oil from Alaska or the gulf would be decades away but, that was written with prices were much lower and technologies more primitive. While some oil could take that long to develop, additonal barrels would come on line in just a few years. Would that effect prices today? I argue yes, the same way an announcement tomorrow that, contrary to our present calculations, Saudia Arabia would run dry in three years would affect prices today.
    Concerning the second question, since we don’t have greenhouse gas restrictions yet, hard data for the additional cost of oil are based on economic estimates. The ones I’ve seen that I trust are bad.

    • Darryl Malcolm says:

      I agree with the author at a high level. I believe he avoided delving into all of the factors for the sake of the KISS approach. Without going into detail, let me bullet just a few other things that would help the U.S. towards energy cost reductions and partial independence:
      – Put in place streamlined initiatives to upgrade our oil/gas infrastructure – refineries, terminals, delivery (rail, boat, truck, etc) and all of the other support mechanisms. Provides a lot of jobs and helps get land locked oil (like N. Dakota) to distribution points – lowering prices.
      – Get the any of the 32 nuclear plants help up by red tape off of the board, as long as they can be secured tight and are in proven geologically sound areas. Supplemental energy and jobs (construction/support).
      – Open up cheap leases on the millions of government owned lands and coastal areas which house huge reserves of oil and gas. Again a lot of jobs.
      – Pump as much money into technology, including promising oil-from-algae farms/refineries to provide low cost (not the current solar/wind dogs) alternative energies. Estimates are a gallon of algae gasoline could be produced for about $1.20, but it is feared that the large multi-nationals are trying to suppress.

      Everything mentioned creates jobs, sends a strong message to the world to influence oil prices downward, and puts the U.S. in the lead of energy technology once again.

  6. Jean says:

    Very interesting. Thank you for your kind responses. I look forward to reading more analysis on current environmental events on your blog.

  7. Daniel Burse says:

    So what then are the answers? What I mean by that is how do you get things done through the Political Process that works with the research and exploration activities?

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