IT HAS BEEN skillfully re-engineered, all the new parts are in place, and it is now on the launching pad. All it needs for a blazing lift-off is some cheaper fuel. Such is the state of the U.S. economy. The tax cut is about to put billions into the hands of consumers. Homeowners continue to augment their purchasing power by swapping higher-interest for lower-interest mortgages. Four of the twelve Federal Reserve districts report improving conditions, and none say their economies are deteriorating. The weaker dollar has given exporters a renewed lease of life. Profits and share prices are showing some strength. Despite some remaining signs of weakness, the general mood is far less gloomy than it has been.
But there may be a spanner in the works: oil prices remain stubbornly high. Lower prices of this key commodity would help put the economy back into high orbit, improving the jobs market and laying to rest fears of deflation. But prices seem headed in the opposite direction, with U.S. crude in the $32 range–well above what experts were predicting when the Iraqi war was won and Iraq’s oil fields were found intact.
Meeting in Qatar last week, members of OPEC were among those surprised at the fact that prices remain at or above their target range. So instead of being faced with the necessity of shoring up prices by cutting production, they were able to keep output at about 1 million barrels per day above its notional ceiling of 25.4 million barrels, subject to review at a meeting scheduled for July 31. The shortening of the usual six month period between meetings shows just how difficult even these industry insiders find it to judge when Iraq will rev up production, and how it will choose to market its oil once it does.
Optimistic estimates of the speed with which Iraq would be able to resume exports on a significant scale did not take into account the deterioration of the fields that were under-maintained by Saddam’s regime, the looting of oil field equipment during and after the war, interruptions in electric supplies, and the unwillingness of technicians to return to work until some mechanism for paying them could be established.
Thamir Ghadhban, Iraq’s interim oil minister, has told the press that he expects to be pumping some 3 million barrels a day by year-end, which is more than the country was producing before the onset of hostilities. That may be optimistic, but if he comes anywhere near meeting that target, OPEC will have to cut output to make room for Iraq, which it plans to readmit to the cartel once Iraq has an oil minister who has been appointed by “an internationally recognized government.”
A flood of Iraqi oil, sold outside the control of OPEC, is the cartel’s nightmare. Dr. Nimrod Raphaeli, senior analyst at the Middle East Media Research Institute, reports that the London-based Saudi daily, Al-Hayat, says “Waves of fear from the future are rolling across OPEC.” Which might not be a bad thing. At last month’s by-invitation-only meeting of top-level industry and government officials, sponsored by Repsol YPF and Harvard University in Salamanca, one leading executive suggested that OPEC is contributing to the misery of the masses of people who live atop but very rarely benefit from the world’s oil reserves. Bijan Mossavar-Rahmani, president of privately owned Mondoil, broke a long-standing taboo: “Is the OPEC-inspired nationalization model best for managing a country’s oil resources?” he asked. “Do OPEC’s collective policies result in the optimal mix of prices and production? What is the level of each country’s oil revenues and where do these go? The answers to these questions are no, no and no one will tell.”
But OPEC’s members are not prepared for a voluntary change in the way they do business. Just last week Saudi Arabia scuttled a plan to allow a $15 billion infusion of private sector capital into its natural gas industry and the related chemical and water industries. The country’s oil minister, Ali Naimi, won his battle to protect the turf of state-owned Saudi-Aramco from trespass by international oil companies eager to regain a toehold in Middle East.
So OPEC will be around for a while, at least until production from new areas, such as Russia, increases. Indeed, if the new producing countries choose to cooperate with the cartel, as Mexico and other non-members have elected to do, OPEC may be a force to be reckoned with for many years. But its policies, and the continued absence of significant quantities of Iraqi oil from world markets, are not the only reasons that oil prices remain higher than was expected.
Despite OPEC’s willingness to keep its taps open, inventories remain at levels the industry deems too low for comfort. Which may be what OPEC intends. Some experts are now saying that inventories are the key price-determining factor, and that so long as OPEC can keep its output sufficiently low to prevent consuming countries from replenishing inventories, it can maintain prices at about current levels.
Moreover, the supply-demand equation in the oil industry is a lot more complicated than merely matching total output with total demand. Refinery capacity is in short supply, and not all types of oil are suitable for all refineries. Venezuela’s heavy crude is used by some, Saudi Arabian light crude by others. This lack of perfect substitutability of one crude oil for another contributed to problems in the U.S. industry when Venezuela was in turmoil, and the crude type on which many refineries rely was unavailable.
All of which means that president Bush can’t safely look to lower oil prices to provide an additional stimulus to the economy in time for his re-election run. He must rely instead on his tax cuts and the Fed’s easy money policy to convert the recovery that seems already underway into the second term that eluded his father.
Irwin M. Stelzer is director of regulatory studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.
