Wednesday, May 07, 2008

Practical Remedies

The price of oil has set consecutive record highs this week, with no end in sight. This energy crisis that has crept up on us over the last four years, doubling the historical average price of oil, doubling it again, and in the widely-reported view of Goldman Sachs heading for a third doubling, is now provoking a sense of panic. You can see this in the flurry of proposals for providing short-term relief from retail gasoline prices that have increased by nearly 60% in the last 18 months. But while most of these ideas would likely be either ineffective or counter-productive, there are a few options that could make a difference this year, without having to wait for infrastructure to be built, fleets to turn over, or new production to come on line.

In order to see what might work, we need to start with a clear understanding of what has driven prices well beyond most experts' expectations, including mine. Rising prices have failed to halt the steady growth of global demand, because many of the countries in which demand is increasing fastest insulate their consumers from the global energy market. Nor has $100+ oil stimulated a flood of new production, because too much of the world's resource base is locked up by nationalist or environmentally-inspired barriers. To make matters much worse, important suppliers such as Nigeria are under-producing due to unrest, while Mexico and Russia are allowing their output to slip because of domestic politics. Instead of giving in to our frustration at these seemingly intractable problems, we can still have a positive impact on them, if we focus our efforts intelligently.

The controversy over food vs. fuel is an example of how tangled this mess has become. Governors and Senators worried about food prices have asked for relief from the aggressive Renewable Fuel Standard put in place by last year's Energy Bill. As sensible as that may seem for addressing consumer-level inflation and an unfolding global food crisis, it could push oil even higher. The market expects a couple of billion gallons of additional ethanol this year, the equivalent of about 100,000 barrels per day of oil. Curtailing that would hardly help high oil prices. So what could we do?

Start with ethanol. For all its many faults, it is an effective oil extender, because most of the energy that goes into making it comes from natural gas, not oil. The most immediately helpful action Congress could take on this front is not a reduction in the ethanol mandate, but a temporary suspension of the $0.54 per gallon ethanol import tariff. That might even address both fuel and food costs, by allowing in more Brazilian ethanol and shutting down the least efficient US ethanol plants. As I've noted previously, dropping the tariff would effectively mean subsidizing foreign ethanol producers, because of the way our ethanol blenders' credit is doled out, but this would cost only a fraction of the lost revenue associated with a summer fuel tax holiday. The volumes involved are small, in oil terms, but with oil prices determined at the margin, every little bit helps.

There might also be more practical and productive uses of America's international influence than prosecuting OPEC for anti-competitive behavior. Instead of pleading with or pressuring Gulf oil producers to increase output, we might talk to them about ending retail subsidies and letting their domestic fuel prices rise to market levels. That would slow down some of the fastest demand growth rates in the world, which are starting to erode oil exports from the Middle East. And if we treated the problems in the Niger Delta with the same urgency we apply to other geopolitical crises, we might be able to mediate a solution that would bring most of the half-million barrels of Nigerian production shut in by rebel action back online. Recent signals from the rebels have suggested that possibility. That would have a salutary effect on the oil market, which has a terminal case of the jitters these days.

Then there's the Strategic Petroleum Reserve. With oil at $120/bbl., it has become an absolute "no-brainer" to stop filling it. Even better, this is one of the few measures that could be accomplished virtually overnight, and it is entirely within the President's power to do so. The switch by the government from buyer to seller--putting the barrels acquired under its most recent royalty-swap contracts back into the market--might not knock $10/bbl. off the oil price, but in combination with a requirement to suspend SPR additions until oil is back under $100/barrel--or better yet, $80--it could help cool off speculation.

Assuming these remedies would actually have the desired effect, we still face an important dilemma with regard to energy prices. As important as fuel price relief seems in an economy already battered by the housing slump and accompanying credit crisis, our goal can't be reducing gasoline and diesel fuel prices to a level that stimulates demand that can't be met without lighting a new fire under crude oil. Furthermore, with a new administration likely to institute climate change policies that will increase energy prices, either directly or indirectly, the chief objection to high oil prices within policy circles is not that they are too high, but that the revenue is going to the wrong people: producing countries and oil companies, rather than the US Treasury. Consumers see this matter quite differently, and until we resolve that divergence of aims, our actions are likely to be as disjointed as our politics on this matter are schizophrenic.

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