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OPINION - April 2005 Why $55 Oil Won't Last When I put a $55 barrel of oil on the table and look at it from all angles, there’s no way the current price can be justified. Oil is certainly flowing today, but at much higher prices. In fact, in real inflation-adjusted terms, today’s oil price is the highest since 1983. To a certain extent, we owe this to a favorable development: the global spread of market capitalism in emerging economies such as China, India and Eastern Europe. At the margin, the increasing oil demands of these countries have undoubtedly boosted the barrel price. It is instructive to note how much higher oil prices have jumped in comparison to other commodities. From the 2001 low, oil has increased 214 percent. Over the same period, an index of metals – equally in demand from the emerging economies – has risen 122 percent. Gold prices have increased 73 percent. The S&P 500 stock index has rallied 55 percent from its late 2002 low point, while the broader Wilshire 5000 has gained 62 percent. The fact that oil has increased so much more than these commodity and financial-asset prices suggests that the oil sector is way out of line. Increased China demand cannot alone explain it – over-speculation is also a culprit. It is rumored that hedge funds have used low interest rates to leverage and borrow for the purchase of oil market contracts. Big oil companies may also be speculating on higher future oil prices, with or without leveraged borrowing. It may also be that tanker companies have slowed down their deliveries as they wait for still higher prices. Fortunately, the U.S. economy is much less susceptible nowadays to the tax-hike impact of higher oil prices. Greater efficiencies in oil and energy usage have lowered our vulnerability to energy shocks by roughly 50 percent in relation to 25 years ago. Ultimately, the answer to high oil prices is more production. New Energy Secretary Sam Bodman has been put in place to implement Bush policies for greater nuclear energy use, increased use of clean coal, the development of a free-trade national electricity grid and the foreign coordination of liquid natural gas. Also in the mix is new oil and gas drilling in the Arctic National Wildlife Refuge. Is Bodman right for this job? Absolutely. Bodman, a chemical engineering scientist who has taught at MIT, was the chief operating officer of the Fidelity mutual fund company and is a former venture capitalist. This is a guy who will quietly manage the U.S. effort to break out of the current OPEC-reliant paradigm and shift to the development of multiple new energy sources. We’re already seeing signs of progress. The Excelon utility company has just received an early site permit for nuclear power, and Duke Power has nearly completed its combined operating license permit, which includes a pre-approved reactor design. Meanwhile, there’s still a lot of oil out there. “Hard Green” author Peter Huber has suggested that there are 3 trillion barrels of oil buried in Venezuela and Alberta, Canada. Washington policy analyst James Lucier also notes that individual states are taking matters into their own hands by exercising states’ rights to drill on the outer continental shelf. In Virginia, Democratic Gov. Mark Warner is expected to sign a drilling bill from his legislature to do exactly that. The key point is to let markets work. Free-market pricing will best allocate the shifts in both demand and supply. Spiking energy prices will reduce consumption. They will also attract capital investment leading to much greater production – if government policies allow markets to work.
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