Reining In Runaway Oil Prices

Last March the Organization of Petroleum Exporting Countries, which supplies 40% of the world’s oil, agreed to cut production by about 6% in an effort to boost crude oil prices. To everyone’s surprise, including possibly its own, OPEC has managed to maintain its output ceiling, taking 4.3 million barrels a day out of production.

Coming at a time of rising oil demand as Asia’s recession-stricken economies are recovering and U.S. economic strength has continued to grow, the action by the 11 OPEC members more than doubled the price of oil. So far Americans have barely felt the pinch of the higher costs, though that is starting to change. Last week U.S. airlines announced they were adding a $20 fuel surcharge to round-trip tickets. Trucking companies are also boosting their rates. In the Northeast, hard-hit by a recent cold snap, heating oil prices have risen 50% in just the past few weeks. The inflationary potential of higher oil prices is beginning to loom larger.

Algeria, Iran and Libya, OPEC’s most politically radical members, are pressing to maintain the production quotas until September. The quotas are currently due to expire in March. That would keep supplies tight through the summer, the season of heaviest demand for gasoline and jet fuel, and would assure steeper prices. Last February, amid a supply glut, oil was selling for just $11.37 a barrel. Last week, the price for oil to be delivered in March reached $28.20 a barrel. With world demand running about 75 million barrels a day, non-OPEC oil exporters, including Russia, have done very well in the run-up of prices.

That the United States hasn’t been hit harder is due to the remarkable transformation in energy use that has taken place since the two major oil shocks of the 1970s. Under the lash of escalating prices and government mandates, industry and individuals have learned to use far more energy-efficient practices. Meanwhile, services, which tend to consume little energy, have taken over a greater share of the American economy.

Though aggregate oil demand has risen in the last two decades, expenditures on oil as a percentage of gross domestic product have dramatically declined. But at some point rising prices are sure to exact a significant toll. Higher costs for oil fall especially hard on the economies of Asia and Latin America, damaging major U.S. trading partners. Some analysts fear that if the OPEC radicals prevail, oil could rocket to $40 a barrel, threatening to set off a global recession.

The course is clear. OPEC’s more moderate members, like Saudi Arabia, should lead the way to restore the balance between production and demand, between glut and shortage. A reasonable equilibrium is in everyone’s long-term interests.

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1999 Crude Oil Prices

Monthly prices per barrel for West Texas Intermediate, the benchmark product.

Source : Weekly Petroleum Status Report