Freeday 22 September 2000

Pic of the day: Oil refinery, screenshot from Transport Tycoon DeLuxe by Microprose.

Crude oil politics

There's a lot of brouhaha about the oil prices these last few weeks. In the news today, the US presidential candidate Al Gore has recommended using strategic oil reserves to achieve a lower oil price as people prepare to tank up their homes for the winter. This may or may not be a good idea; but the high oil price is not a certified Bad Thing. In fact, it is a good thing. And I shall try to explain why.

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First a brief overwiev. Prices of high quality crude oil have risen from about $10 a barrel last year to about $30 this year. The prices of paraffin, diesel and gas (petrol) have of course increased too. The effect is most dramatic in Europe, where many countries have high carbon taxes in order to curb CO2 emissions. (Well, actually it is probably to raise more tax revenue for pet projects by politicians who like to play Santa Claus, but officially it is to protect the environment from global warming.)

Lorry drivers in many European countries have reacted with spontaneous protests. (This includes ironically also Norway, the world's second largest net exporter of oil, and with Europe's third lowest oil prices compared to after-tax earnings.) The high transport costs are starting to choke the economic expansion, both directly and by adding to inflation. The central banks react to inflation by raising interest rates, further damaging investment.

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The key to this artificial oil crisis however is the USA. The American economy is still booming, and this requires lots of energy. Not just for the industry: People are feeling wealthy and travel much more than they used to, burning oil products at a furious rate. And domestic energy consumption is rising as people no longer feel the need to save on heating, cooling and lighting.

The USA is also violently opposing any plans to end the Iraq oil embargo. This is certainly understandable: It would be political suicide to aks your mad dictator arch enemy to help you out and end the oil crisis. Though it would certainly be efficient. The oil price would fall like a shot duck, as Iraq has a substantial production capacity and is ready to pour out oil on short notice.

The main reason for the high oil prices is however the global economic growth. Before the recent low oil prices, there had been a global setback. I think most people are unaware (or have already forgotten) that the world economy was on the brink of its greatest collapse since the 1920es. The East Asian economies were collectively bankrupt; Russia defaulted on its giant foreign debt; Latin America was sinking fast; Japan was in the middle of a long deflation; and Europe was stagnant. In the USA, a large and famous hedge fund collapsed, and the Federal Reserve had hours to decide the future course of the world economy. The Fed chose in effect to overheat the American economy in order to pull the rest of the world out of recession, and succeeded. What's almost more improbable than Alan Greenspan's steel nerves is the fact that the politicians did not panic and try to put their hands on the wheel.

What has happened is that most of the world is now back in gear. The emerging economies are emerging once again, and industry is picking up in the industrialized countries. This is where all the oil is going. Shopping for oil is based on expectations for the future, since you can't just teleport it from the oil well to the gas tank; it takes months of processing and transport. The current high price is based on the high expectations of future activity. This is, by most standards, a good thing. (Except possibly for the environment.)

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If oil prices did not hit the roof, then other resources would. Most notably, in the USA the pool of free labor is now very small. We must remember that not all people can do all kinds of work: Some have a more specialized education, and not all are physically or mentally able to take all kinds of jobs. Also many jobs still require you to be physically present in one particular place, and if the costs of living there are too high then you cannot get cheap labor regardless how many may hang out elsewhere in the country.

From earlier economic expansions we also know that the price of property, especially business property, tends to grow out of normal bounds towards the end of the expansion. Capital bound up in property is very hard to release when the economy cools and starts to shrink. Laying off excess workers is also a painful process, likely to hit company morale even in those who remain. In contrast, high oil prices will go down pretty quickly when the boom ends.

In conclusion, then: The high oil prices are a result of rapid economic growth, and they help slow down the pace of growth to a more sustainable level. And they do so in a fairly humane way. To top it all, this will probably stimulate invention in fuel saving and renewable energy sources. It is, in short, a certified Good Thing.