Oil: Well?

The president can't do much about gas prices. Try telling voters that.

| Thu Apr. 1, 2004 3:00 AM EST

The price of oil, at around $38, is already at a thirteen-year high, and it's not coming down any time soon thanks to OPEC's decision on Tuesday to cut production by 1 million barrels a day. As the Wall Street Journal notes, the OPEC squeeze, effective today, "could drive prices past the psychologically important threshold of $40 a barrel even as U.S. customers are already complaining about high gasoline prices."

There's no question that for drivers -- which means Americans -- the price of gas is about as basic a pocket-book issue as there is. Or that the U.S. economy, which to a large extent runs on oil, feels the effects of high crude prices at almost every level. That's why Bush and Kerry have been going after each other over the price of oil this week. But politics aside, there's surprisingly little agreement over how much of a threat the $40 barrel presents to the U.S. economy.

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OPEC cited robust demand for crude oil as the main justification for its decision, and it's clear that industrialized countries and (especially) China are guzzling more gas than ever. China alone is estimated to consume 5.4 million barrels per day in 2004. Overall, the Washington Post reports, world demand grew by 1.4 million barrels per day last year and is expected to grow an additional 1.5 million barrels this year. That said, the production cuts are intended in part to offset an expected decline in price during the coming spring and summer months when Western countries turn off their heat (but, inconveniently, when Americans hit the road).

On the supply side, OPEC countries report that they are “overproducing above [their] quotas” -- taking advantage of the current high prices by pumping as much oil as they can, exceeding their target by an estimated 1.5 million barrels. The U.S., reports the Wall Street Journal, has its own problems with supply. Domestic refining capacity is tight, while new environmental regulations calling for much lower sulphur content have caused gasoline imports to drop by a third.

And then there's what analysts call "supply-disruption risk." Political troubles in Venezuela, Nigeria and Iraq have always had the potential to interrupt exports; now there's the additional fear of terrorism targeted at oil infrastructure. All of which puts pressure on oil prices (and, perversely, makes oil a more attractive investment for speculators. An oil analyst tells the Economist that the amount of speculation in oil is "more than I've seen in a very long time." This puts an "unprecedented premium" on the price of oil, driving it up further.)

But despite claims that Americans' gas prices -- more than $2 in California -- are at a record high, they're in fact well short of an all-time high when adjusted for inflation of $2.97 a gallon in March 1981. The Economist last week wondered what all the fuss was about.

[T]he increase has not been as large as it looks. Oil prices this week were roughly a third higher than their average level in the four years to 2003. That is much less than the tripling of oil prices in the 1970s, in 1990 and again in 1999-2000. These rises were big enough to help cause global economic downturns. But following the latest rise, real-dollar oil prices, after adjusting for inflation, are less than half their peak in 1980. Furthermore, part of the recent rise reflects the weaker dollar, in which oil is priced. In euro terms, oil prices are barely higher than their average of the past four years.

But look beyond the most energy-intensive sectors, and the notion that high oil prices are quashing demand and wrecking firms is overdone. One reason: OECD economies are less energy-intensive than three decades ago when the first oil shocks occurred, thanks to the shift out of manufacturing into services and information technology. And, in real terms, even the current "high" oil price of over $38 a barrel is still below half its historic peak.

So, nothing to worry about? Well, not quite. This quite different take comes from ... the Economist -- specifically its "Buttonwood" columnist.

Goldman Sachs now thinks that the world economy will grow by 3.8% this year, not the 4.6% it had originally forecast. The main reason for this sharp reduction is the sustained rise in the price of a commodity long dismissed by most economists as having little impact on mature economies: oil. ...

America may be more efficient than it was, but it is far from immune to higher prices. For consumers, the recent sharp rise in petrol prices-which hit an all-time high this week-is, in effect, an increased tax burden. And it comes just as the effects of Mr Bush's (official) tax cuts start to wear off.

But there is an indirect effect on consumption, too. Costs are rising for companies as the price of oil and other commodities goes up. ... To stop profits from falling, American companies must keep a tight lid on labour costs. As Mr King puts it, shareholders have been benefiting at the expense of those who work for them (though not CEOs, of course). A prolonged rise in the price of oil and other commodities would make this problem still more acute: America's jobless recovery is likely to stay jobless. This would eventually kill the recovery, since consumers in fear of their jobs are unlikely to carry on splurging.

America's politicians are more likely to be in Buttonwood's camp than his colleague's. As Gene Sperling, an advisor to John Kerry, tells the Wall Street Journal, "Rising gas prices are one of the most transparent in-your-face hits on the pocketbook there are. I don't think there's any White House that wouldn't see this as a concern."

So this week Bush and Kerry were both on the offensive over gas prices. Republicans are pummeling Kerry for 11 years ago speaking in favor of a 50-cents-a gallon gasoline tax, and for more recently pushing higher fuel-efficiency standards for cars. Bush administration officials have suggested they'd leverage interest in bringing down gas prices to press the Senate to act on its controversial energy bill. Kerry has proposed temporarily suspending purchases of oil for the nation's Strategic Petroleum Reserve, and he blamed the Bush administration's energy policies, saying ""The United States of America can't drill its way out of this predicament; we have to invent our way out of it." In that spirit, he unveiled a blueprint for "energy independence."

In fact, the president can do very little to influence the price of oil, short of bringing influence to bear with OPEC, and especially Saudi Arabia. Bush, notes the Journal promised in 2000 that he would "jawbone OPEC" and exploit his "political capital" in the Middle East as the son of a president who liberated Kuwait. Clearly it hasn't quite worked out that way, with the U.S.'s stock having sunk to new lows in the Arab world. Writes the London Observer's senior economics commentator William Keegan.

[O]ne of the principal reasons why the US invaded Iraq in the first place was the concern of a powerful US government faction about the long-term security of oil supplies, in view of the potential political instability in Saudi Arabia. Of course, now they have added instability in Iraq as well.

It may be that Bush (or Kerry, as president) can do little about gas prices, but try telling that to voters paying over $2 at the pump. Given that most American’s are feeling protective of the limited economic growth that has occurred in the last few months, high gas prices may very well be one of the little things influencing voters in November.

And, as Buttonwood notes, "Goldman Sachs now thinks the American economy will grow by only 2.75% (on an annual basis) in the second half of this year and the first half of next-a forecast it has revised down by three-quarters of a percentage point. It might, Buttonwood thinks, even turn out lower than that. Slower economic growth in turn bodes ill for stockmarkets and corporate-bond markets. And if markets tumble, consumer confidence will surely follow. The rise in the oil price, in other words, may leave nerves not so much frayed as in tatters."