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27 June 2012

OPEC (Oil Prices Explain Crisis)

On the Deep End we don’t exactly overlook the contribution of the Eurozone to the great economic crisis of our times. But there is another multinational enterprise that deserves the occasional mention – the Organisation of Petroleum Exporting Countries (OPEC).

Writing for the American Interest, Gal Luft and Anne Korin remind us of the importance of oil prices to the economy: 

  • "All but two of the post-World War II recessions were preceded by a sharp spike in oil prices; there is no question that the fivefold increase in oil prices since 2003 has contributed to the current economic dislocation. For perspective, forty years ago, at the zenith of the Cold War, the United States spent $4 billion on oil imports, an amount that equaled 1.2 percent of the defense budget. In 2006, the United States paid $296 billion, equal to half of the defense budget. By 2008, U.S. foreign oil expenditures grew so much they almost equaled the entire defense budget." 

It’s become common for politicians – especially American politicians – to worry about the extent to which we depend on oil imports. But as Luft and Korin point out, it is price not supply that is the real problem. The market for oil is thoroughly globalised, therefore there’s not much that oil producers can do to block supplies to particular importers. But at the same time, there’s not much that importers can do to reduce their consumption – at least not in monetary terms: 

  • "…when major consumers reduce net demand for whatever reasons, OPEC responds by throttling down supply to drive prices back up to its ideal price level, what it calls a ‘fair’ price, or just sitting on its hands while developing world demand picks up the slack. The thing is, this ‘fair’ price keeps rising. In 2004, OPEC’s ‘fair’ price was $25 per barrel. Two years later it was $50. In 2010, OPEC’s secretary general, Abdalla Salem El-Badri, argued for $90, and by the end of 2011, with OPEC’s oil revenues topping $1 trillion, he adjusted the price to $100."  

Thus while America has reduced the quantity of oil it imports, the total cost keeps going up. There’s every reason to think that this will continue: 

  • OPEC’s "fair" price is based ultimately on the budgetary needs of the cartel’s members, whose appetite for petrodollars has increased significantly since the onset of the so-called Arab Spring. Hoping to avoid the fate of leaderships in Egypt and Tunisia, Persian Gulf regimes have showered their people with gifts and subsidies. Saudi Arabia alone almost doubled its budget, committing $129 billion to entitlement programs." 

Luft and Korin say that the only way out for the west is to switch from oil to a different fuel altogether – preferably one not controlled by a cartel of hard-up despots. This would, of course, be a major undertaking – but since when did small ideas solve big problems?


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