Hurting at the pump? Go ahead. I give you permission. Blame the government. Not just the U.S. government, but governments all around the world. Given this, resist the temptation to beg for new magical government plans to cure high prices – the solution will be found in less, not more, government intervention in the oil market.
Even with Saudi Arabia’s announcement to increase output, the structural conditions, which threaten the stability of the oil market, remain unchanged.
Examining the situation internationally, more than 75 percent of all proven oil reserves are controlled by governments. Government-based firms do not act economically rational like free-market firms. In a free market, when prices are high, firms looking to maximize profit expand production. The outflow of supply lowers prices to the benefit of the consumer. This is less likely to occur when national bureaucrats control the outflow.
Oil-producing bureaucracies factor in external geo-political issues, not just consumer needs. The Organization of the Petroleum Exporting Countries has used oil exports as a weapon to sway political issues. Free market firms are less likely to maintain a cartel as economic incentives guide the firms to produce more to drive down the artificially high cartel prices.
Domestically, the situation is no better. Government regulation hampers the growth of domestic refineries, and promising oil locations, such as Alaska and offshore sites, are cut off from possible production. Roughly 85 percent of the U.S.’s offshore area is off-limits. This area is estimated to contain more than 85 billion barrels of oil. More production domestically will increase supply and potentially decrease prices.
Without a doubt, speculators have contributed to current high oil prices, but what is widely missed is the legitimacy of their fears. As Dom Armentano, a professor at the University of Hartford, said, "To be sure, speculators have helped bid up the price of crude oil. Most of the speculation centers around legitimate concerns about ‘supply disruptions’ and some wider war in the Middle East Gulf region."
With a new round of saber-rattling from the Israelis, and both presidential candidates leaving military conflict with Iran on the table, the war risk premium on each barrel of oil shows little sign of changing.
Frank Shostak, chief economist at M.F. Global, in his article "The Oil-Price Bubble," recognized the supply side issues, but also put blame on the loose monetary policy of the Federal Reserve. The significant drop in the federal funds rate to 1 percent from 6 percent created a misallocation of resources, which manifested itself in putting pressure on oil prices to rise.
Concurring with stronger words, Paul Van Eeden, president of the investment firm Cranberry Capital, makes monetary policy the No.1 factor in the devaluation of the dollar, causing the rise of oil prices. Eeden places the manipulation of the dollar by the Fed, not manipulation of the oil markets or the increase in demand by foreign markets, as the core problem.
These operations help reveal thel central political issue, that government bureaucrats and Fed manipulators are quick to blame the free market operations for such price increases. It is important to realize that because of the degree to which these markets are kept restricted, we will continue to see erratic price fluctuations.
Gilson, a Business sophomore, can be reached via [email protected].
