Sunday, June 06, 2004

Yet more on the Oil Story

Gavin is thinking about oil, which is fortunate, because so am I. I would take issue with the article from the Washington Montly he posted.

My riposte needs tons more data to be anything near effective, so this is a draft of one to start with. Like the story linked by Gavin, it's a piece of Sunday newspaper economics, a plausible story around a limited number of facts, with little theory and not much empirical support.

First, the shortfall in investment has been predicted. The IEA has been writing for the last five years that the cash-strapped and hidebound OPEC states need to open up to foreign investment go get more of their oil out of the ground. Progress on this has been slow and painful, with Exxon pulling out of talks with the Saudis after several years of dickering.

Second, spare capacity has been declining for a logical reason, namely that it was built by mistake. The producers got it wrong and built up to meet their overoptimistic forecasts of demand. It's convenient to have this spare capacity, mostly concentrated in Saudi, because it can be maintained as a weapon to enforce monopoly power by threat of price war. In a perfectly competitive market, where every producer is a price-taker, none would rationally build this extra production capacity. So, perhaps this is a sign that the oil market, with Russia resurging and new capacity coming on in Africa and Asia, OPEC faces a more competitive market.

Third, American military policy remains that anyone threatening the Saudi oil fields gets a big smack, which is pretty much unchanged since FDR and Ibn Saud first tied up the alliance. Remember how Iraq got whacked for trying? As Iran did in the eighties for threatening shipping in the Gulf? If you want someone to blame, go for Roosevelt. His successors, have had the same policy, and LBJ, Nixon, Reagan and Bush 41 have all used military force, given aid to their allies or made threats.

Fourth, oil demand is quite sensitive to both the state of the economy and the price of oil itself. America uses about 25% of the world’s oil output, 13% goes to motor fuel and about 1% to aviation, according to the IEA (Monthly oil market report, 12 May 2004, tables 1 and 3). If the fuel costs go up, both can be quite reactive – people will do less driving and then buy more fuel efficient cars when they next switch, probably within two to three years at most, and air travel will be cut back. This is probably the key to balancing the market, I expect, but it should be based on an analysis of the statistics, not sweeping generalisations.

As for petrol queues – when the late Mr Reagan abolished price controls on oil, the gas lines disappeared. This was simple common sense in action – once the price was unconstrained, supply was no longer withheld.

The previous oil crises did occur around the time of major recessions. The rule of thumb (reported in an FT article that’s on my office desk but not here at home) is that every $10 to the oil price means a 0.5% fall in growth. With US GDP growth at 4.4% year-on-year in Q1 ’04, a rise to $100 dollar/bbd would be serious but hardly fatal. The oil weapon has been brandished so often that the sensitivity, certainly in Europe, America and Japan, to it is somewhat diminished.

As for this finally being the crunch point, I remain to be convinced. As I’ve said above, almost all energy scholars refute the peak oil thesis, which seems to have a serious following only among quite fringe parts of the environmentalist movement. Note also that the interests who would benefit most from having this widely believed, namely oil producers who would benefit from high prices and slower depletion aren’t pushing this line, having been very hard by over-aggressive price forecasts in the eighties.

I have a problem with the WM article, and efforts in a similar vein, namely that journalists, especially the Yale English grads who write for these limp-wristed East Coast, Ivy League, liberal club magazines don't really know very much about the hard disciplines that should be the foundation of analysis of the energy market or have the practical experience of involvement and decision-making. Geology is one such discipline and my own field of economics another. In particular, the latter would dismiss these attempts at prediction without reporting data and testing them carefully. In the case of this article, the complete absence of a model which involves some research time and good reporting, which I think is lacking in the WM’s piece.

As a rule of thumb, I generally find that most of the economic analysis in the media is seriously and fundamentally flawed, which is why I try to go deeper and use different sources. I’d recommend anyone who can reads Paul Krugman’s excellent book “Pop Internationalism” for a more detailed analysis in the context of the debate on international trade and “competitiveness”.

Yours journalistically,

Peter 笔德