A Real Energy Policy
by Brian Lynch
 One "price bubble" that has, so far, gone largely unexamined (but not
un-commented upon) is the price of oil. There is absolutely no fundamental
reason
for petroleum to be hovering above US$60/bbl. Inflation, which was induced
by the excessive money creation of the Federal Reserve over the past few
years, has only been sufficient to take oil from its 2000-2002 price range
of US$20 to US$25/bbl into the US$30 to US$40 range. Most of the rest of the
run-up is pure speculation in oil derivatives, primarily at American hedge
funds.
Hurricane Katrina, which smashed into the Gulf Coast of the U.S., has
temporarily harmed oil production and local-area refineries. In the months
ahead, however, both production and the refineries will recover (half of
them are projecting full resumption of operations by October 1). The impact
of current oil prices will not last. Long-term oil fundamentals remain
unchanged: Inventories are full, China has been scaling back its purchases,
and vast supplies of oil and gas are slated to become available in the next
few years, purusant to oil lease and drilling rights negotiations between
governments, and integrated oil companies.
The fundamentals in the oil business are supply and demand. Supply has run
ahead of demand in recent months (validating a core axiom of supply-side
economics: rising prices act as an inducement for suppliers). The world's
oil distribution networks can only hold enough excess capacity to last for a
few weeks. Strategic reserves, industrial storage, tankers, and every other
available excess capacity absorber is at or near full. There is no place to
put much more excess production. Katrina knocked out primarily refining
capacity in the United States. But refineries in foreign countries are
stepping in to take up the slack (why not--after all, U.S. drivers pay more
than locals).
The precise date that this oil-price balloon will pop is not predictable,
but the end of a market distortion as large as today's oil prices is.
President Bush could perform a public service by ending this oil mania
fairly soon. How?
He should first continue to do what he's now doing with the Strategic
Petroleum
Reserve. In the aftermath of the Gulf Coast catastrophe, the President
ordered that oil be sold from the reserve to meet the temporary shortfall in
production. Previously speculators had banked on the fact that Washington
was a steady buyer of oil, no matter the price. If the government announced
that it was now becoming a seller and that its selling would continue beyond
the hurricane-caused shortfalls, the price of oil would quickly collapse by
at least $15 to $20 per barrel as hedge funds were forced to cover their
positions, either selling current contracts or buying lower strike-priced
futures.
The Administration is reluctant to do this because it's convinced that most
major global suppliers are politically unreliable and unstable. But we
already have more than enough oil in the reserve to cover any temporary
disruption in supply from another country. Officials seem obtuse here:
unwilling to grasp the fact that both oil and money are fungible.
Even Castro-like leaders such as Hugo Chavez in Venezuala are not going to
stop selling us oil. The reason is simple: no matter how much they dislike
the United States, even authoritarian socialists need the money. At over
US$60/bbl, that cash will buy him a lot of domestic support (votes).
Remember: he was willing to sell us all we wanted when the price was arounc
US$30/bbl. We needn't fear not having enough oil to fuel our economy.
Second, gross distortions of prices above (or below) what can be sustained,
given known supply and demand are not entirely baseless. Fears of terrorism,
wars, and other unforseen disruptions to supply have added a risk-premium of
at least US$12/bbl (more likely US$16--18/bbl) to prices. The terror premium
is closely linked to the failing U.S. "war on terror", and the growing
realization that there is no strategy in place to win, nor is there a set of
mission objectives that define 'victory'.
The solution indicated here is an old one, which was executed effectively in
the late 1700's and early 1800's, against pirates in the Carribbean Sea. The
Congress can (and in my opinion, should) issue Letters of Marque and
Reprisal against members and supporters of anti-U.S. terrorist groups. These
would be a far moer cost-effective means for conducting an offensive than
the current (ineffective, failing) "war", which requires the mobilization of
several nations' militaries.
One of the critical inputs that drives modern economies is energy. With
energy costs rising, the potential for inflation to depress investment and
savings is growing. Future prosperity depends on sustaining capital
investments that maintain productive assets, and fund new developments. Oil
prices would probably fall to under US$40/bbl by spring 2006 if the releases
from the SPR were made part of an ongoing program to stabilize oil prices,
and if there were clear successes at neutralizing, disabling, or terminating
(with prejudice) terrorists -- by whatever means were required.
The 2006 U.S. elections (like previous elections) will turn on the economy.
Specifically, the question posed by Ronald Reagan in 1980: "Are you better
off today than you were [x] years ago?" High oil prices (and the shortages
that resulted from that administration's feckless foriegn policy) were a
major part of what destroyed Reagan's election-opponent, Jimmy Carter. The
sense that the USA has been diminished that destroyed Carter is taking root
in the USA today with Republicans in control of the legislative and
executive branches. They are no less potent as 'weapons of mass political
destruction' today.
So, what are people in D.C. waiting for?
Brian Lynch, FYI Econometrics, Austin, TX USA
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