6/1/2004 | 2 MINUTE READ

Oil Prices

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When allowed to work, the market can be quite efficient.


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When Shell admitted its oil reserve estimates were overstated, the predictable chorus of doom used this as “Exhibit A” in a media star chamber against the continued use of fossil fuels. And it did not take long before China’s growing wealth and concomitant appetite for cars and trucks was being used as a wedge against those who cautioned against panic, or suggested the market would adjust to meet the demands of this situation—should it ever develop. Soon, the Internet bristled with conspiracy theories—and theorists—about the “real” reason for the second Gulf War, and U.S. complicity in the 9/11 attacks. Others suggested the Chinese are stealing “our” oil and would use it as a weapon with which to dominate the Western world in the coming years. Unfortunately, I never had the chance to research whether these were the same people behind conspiracy theories about the loss of U.S. manufacturing jobs, and I never saw a web page suggesting the Chinese were stealing manufacturing jobs in order to build cars that run on all that stolen Western oil.

Nevertheless, what this whole media panic has proven is the sad state of economic education in this country. Nowhere was it written that Shell’s reserves didn’t exist—though that was intimated in headlines and stories alike—just that the reserves weren’t “proven.” That is, by using current accepted technologies and economic assumptions (i.e. the price of a barrel of oil, the cost of an hour of labor, etc.) this oil economically could be recovered. Which isn’t the problem you might think it is. After all, though the oil industry says known reserves (calculated by taking the remaining known reserves divided by the production rate of the last year for which data is available) are approaching their peak at 40 years, it said the same thing 30 years ago.

In addition, the rising per barrel price of oil is seen as “proof” that the party has come to an end, and oil supplies are dwindling. Oh, really? If true, it would be the first example of economically correct reporting about this subject as prices do rise as supplies shrink—something politicians and journalists alike forget when prices rise momentarily following a natural disaster. Unfortunately, one need look no farther than the Strategic Petroleum Reserve (SPR), OPEC production pronouncements, and the coming election to see the real reason behind the jump in oil prices. OPEC wants its purchasing power to remain stable as the dollar declines, so it eases back on production. The Administration doesn’t want to look like it’s manipulating oil prices in an election year, so it continues to fill the SPR as prices rise. And speculators—those dabbling in oil futures—make a killing as preemption of its use keeps prices at record levels.

What’s missing in all of this is the fact that when the president’s father called speculators’ bluff by authorizing the release of 2.5 million barrels/day from the SPR in 1992, oil prices fell by almost 50% overnight and stayed there through 1999. Doing the same today would have a similar effect, and again squeeze speculators out of the market while fueling U.S. industrial production. True, eventually we will have to find another source of fuel. However, when prices rise as supplies really start to dwindle—about 80 years from now, says the oil industry—“backstop” technologies—those recovery techniques, deposits and fuel sources that are economically unviable today—will fill in the gaps. When allowed to work, the market can be quite efficient.


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