[IP] Hudson Institute Economic Update
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From: Hudson Institute <marketingcomm@xxxxxxxxxx>
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Date: Mon, 21 Jun 2004 15:05:33 -0500
Subj: Hudson Institute Economic Update
ECONOMIC NEWS UPDATE
IRWIN M. STELZER
21 June 2004
When markets talk, politicians would do well to listen. The oil markets are
doing more than mere talking -- they are shouting for the attention of
policymakers who seem determined not to listen.
First, we have the recent run-up in crude oil prices, which fluctuate around
$40 per barrel. That rise was in part due to the fabulous growth of the U.S.
and Chinese economies, which sent demand for oil soaring. But a further driver
is OPEC's manipulation of the market, creating a situation in which rising
demand cannot elicit the increased supplies that would flow in a competitive
market.
Lesson number one for policymakers: it is no longer prudent to ignore the OPEC
cartel, or to rely on it for mercy. Trust busters have had time to worry about
less important price conspiracies -- the commissions charged for selling old
master paintings is less likely to affect the economy than is a conspiracy to
fix oil prices -- but have shied away from attacking the OPEC cartel. Now would
seem to be the time for the voice of the Antitrust Division to be heard above
that of the State Department, ever-eager to avoid a diplomatic row with the
house of Saud.
The markets are also saying something about the state of the gasoline market.
The margin between crude oil prices and gasoline prices has doubled in the
United States, driving refining profits up several hundred percent. Yet,
refining capacity has not increased. Oil industry executives with whom I have
spoken say that environmental and other permitting restrictions make it
virtually impossible to build new refineries. Lesson number two for
policymakers: restrictions that were appropriate when crude oil was selling for
$10 per barrel and gasoline for $1 per gallon are not economically sensible at
current price levels. Revise them to allow more refineries to be built.
These are important messages from the market. But not as important as the
persistence of the so-called risk premium of between $5 and $10 per barrel that
seems to be built into crude oil prices. Part of that premium is a response to
the continued disruption of supplies from important producers. Terrorists in
Iraq periodically sabotage that nation's pipelines. Unrest and violence in
Nigeria, Africa's largest producer, make that country an unreliable source of
oil. Islamic terrorism casts doubt about the reliability of supplies from
Kazakhstan.
Add self-inflicted wounds by important producers. Russia, which rivals Saudi
Arabia as the world's largest producer, Vladimir Putin and his old KGB buddies
have frightened foreign investors by jailing the country's richest oil baron,
Mikhail Khodorkovsky. Venezuela's Castro-loving president, Hugo Chávez, has
replaced the nation's skilled oil industry managers with political appointees,
causing a loss of 500,000 barrels per day of production from that important
supplier of the low-sulfur oil most suitable for use in U.S. refineries. Iran's
mullahs have stifled the foreign investment that Iran's oil industry so
desperately needs.
But even these multiple threats to a steady flow of oil pale by comparison with
developments in Saudi Arabia. The Kingdom sits on 25% of the world's known
reserves, but that figure understates its importance. The Saudis can tap their
reserves for over 80 years without slowing output. And it is well known that
the Saudis haven't really attempted to explore for new reservoirs because they
already know precisely where some 260 billion barrels are located. "You don't
plant potatoes when you have a cellar full of spuds," a grizzled denizen of
America's "oil patch" once told me. Not only are the Saudis sitting on the
largest known reserves, and on the cheapest, most easily discovered as-yet
"unknown reserves," they are also the only country in a position to increase
production quickly should some other supplier be knocked out of action.
But Saudi Arabia is no longer the stable rock in a turbulent Middle East sea.
The terrorists funded by the Saudis have turned on their benefactors, and are
killing foreigners to cause a flight of oil-industry and other trained
personnel. They are winning because they seem immune to capture, because many
top Saudis insist that it is the Zionists, rather than Al Qaeda, that are
causing the mayhem, and because hundreds of thousands of unemployed youths see
no future for them so long as the royal family siphons off the nation's wealth
to support its opulent lifestyle.
Whatever the reason, it is far from certain that the corrupt geriatrics who run
the country will be able to head off the threat to the Saudi industry's ability
to produce a steady flow of oil. True, the production facilities are well
protected, but by troops of uncertain loyalty. And pipelines are difficult to
protect, as are port facilities.
Final lesson for policymakers: prepare for the day when bin Laden and
associates are in a position to topple the Saudi regime and withhold supplies
of oil, causing a major economic trauma in industrialized countries and a
humanitarian catastrophe in the undeveloped world. That means continuing to
build strategic reserves, but much more. Alternative sources of energy for
transportation uses cannot be available in the relevant time frame, if ever;
places such as Alaska take a long while to develop, and anyhow don't have
enough oil to matter; renewables such as solar and wind power are not
replacements for gasoline; conservation can be useful when prices rise
gradually, giving consumers time to adjust to higher prices, but not when there
is a price explosion.
I was asked many years ago at a gathering of government and industry experts to
lay out an energy policy for America, to cope with a supply interruption. Two
words: "aircraft carriers." That remains true today. Iraq is not a war for oil.
The next U.S. intervention in the Middle East may well be.
A version of this Update appeared in The Sunday Times (London)
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for
Hudson Institute. He is also the U.S. economist and political columnist for The
Sunday Times (London) and The Courier Mail (Australia), a columnist for The New
York Post, and an honorary fellow of the Centre for Socio-Legal Studies for
Wolfson College at Oxford University. He is the founder and former president of
National Economic Research Associates and a consultant to several U.S. and
United Kingdom industries on a variety of commercial and policy issues. He has
a doctorate in economics from Cornell University and has taught at institutions
such as Cornell, the University of Connecticut, New York University, and
Nuffield College, Oxford.
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