FMC Blog: Free Speech Zone

The Price of Oil

No topic is more misunderstood than the price of oil and the oil industry in general. Most politicians and writers, who comment on the recent rise in the price of oil, its causes, and implications, simply have no clue what they are talking about.

The world is not facing an oil crisis and the price of oil is not exclusively determined by OPEC or any other organization or cartel. Today, every major oil producer, whether in Europe, the Middle East, Asia, Africa or America can influence the price of oil.

The point of this article is that the United States is not facing a crisis, nor is it addicted to oil and the United States government should allow the free enterprise system to responds to higher prices rather than politicians or government bureaucrats who don't understand the energy market.

It should be noted that this is not the first time the world experienced high oil prices. The world initially experienced a sudden increase in oil prices in 1973 and again in 1981. As a consequence of the rise of oil prices in the 1970s and early 1980s, oil production became profitable all over the world and every country that had the ability to produce oil raced against time to increase production and explore for oil. By 1985, world oil production had increased so much higher than demand that the price of oil simply collapsed and the world experience approximately 20 years of dirt cheap oil prices.

As a result of cheap oil, production and exploration naturally decreased because available oil supply was substantially higher than demand and producing additional oil was not economically feasible.

Then China, India and Brazil, among other countries, decided they no longer wanted to be poor. China's economy has grown at a phenomenal and unprecedented 10% annual growth for 10 straight years. At no point in modern history has a large nation experienced such consistent and explosive economic growth. Add India to the equation and within a short period of time two impoverished nations with 2.6 BILLION people were suddenly able to put down their bicycles and pick their car keys. Predictably, demand for oil and other natural resources increased substantially.

Within a short period of time, India and China went from exporting oil to becoming major oil importers. Consequently, the excess global oil capacity, which once numbered eight million barrels per day, was reduced to two million barrels per day. That is correct; the world is still producing more oil than demand for oil. However, because supply is only slightly higher than demand, the market is constantly on edge. Thus, news of Hurricane Katrina, rebels in Nigeria or the nuclear dispute with Iran tends to make the market nervous because several nations produce more than two million barrels per day and the fear that anyone of them may face a disruption keeps the market on edge and invites speculators to invest in oil in the hope that demand for oil may rise faster than supply or a disruption in supply would push prices to the sky in which case, investors would reap enormous profits.

The problem of oil supply has been exasperated by western nations, including the United States, who refuse to allow drilling for additional oil. The refusal to allow additional drilling is interfering with the free market system from efficiently responding to high oil prices. It is absolutely irresponsible for the United States government to prevent the oil industry from producing oil anywhere and everywhere that oil maybe found and produced in an environmentally sound way.

Some argue that allowing additional drilling will only produce one million barrels of oil per day. (As if one million barrels of oil per day is insignificant.) What those people don't understand is that it is not the amount of additional oil the United States produces that counts; it is the amount of additional global capacity that makes a difference. Thus, one million additional barrels in the United States, one million in the Middle East and one million in Latin America will make a huge difference when added together if the end result is substantial excess oil capacity. Even if substantial excess capacity is not possible, continuous exploration and production is necessary to keep up with the additional demand from China and India. If western nations refuse to explore and drill for oil, then demand may one day surpass supply and the price of gasoline may reach $10 per gallon, a price that may damage the U.S. economy and cause enormous suffering for the poor of the world.

As to government intervention, the United States government should do NOTHING to artificially interfere with people's energy consumption habits. The government should get out of the way and let consumers and the free market respond to oil prices. Government intervention is more likely to cause additional problems than provide solutions. A case in point is the government mandated use of Ethanol which most experts credit for contributing to the global rise in food prices.

Over the last five years, the American car industry has responded to high oil prices by taking numerous steps to improve the efficiency of their automobiles. For example, GM, Ford and Chrysler began mass producing vehicles with cylinder deactivation technology whereby a vehicle switches from eight cylinders to four cylinders when road condition allow for such reduction in power and energy consumption. GM is near completion of the Volt, a new car that promises to take energy consumption to new lows. All car companies are now producing hybrids. The point here is that the car companies did not take the above mentioned steps because the government asked them to change, they began changing their cars when their consumers and the free market demanded more efficient cars.

As to other forms of energy, such as solar, wind, hydrogen, etc., the market and consumers should decide the extent of their use. The consumer will naturally begin using other forms of renewable energy once it becomes cost effective to do so. The fact is, oil continues to be the most cost effective and efficient of the available sources of energy. This is a fact that should not be denied for political reasons.

Posted August 24, 2008 by Kamal Nawash