Mixed blessings of the declining price of oil


WITH THE price of oil tumbling, the 13 OPEC oil ministers, meeting in Geneva, attempted to set a new target price of $21 a barrel. To achieve that price, they agreed to cut production by 5 percent, and allocated new quotas accordingly.

Saudi Arabia, which boosted oil production to peak levels during the Persian Gulf war, will cut its daily output by about 500,000 barrels to eight million barrels, compared with its pre-war output of 5.4 million. But other producers, such as Algeria and Iran, expressed dismay that the 5 percent cut will not be sufficient to raise the price much above the current $17 range.

The weakness of the cartel and the declining price of oil add up to a mixed blessing. On the one hand, cheap oil gives consumers more money to spend on other things and stimulates the economy. On the other hand, it depresses oil production and exploration in regions where oil is more costly to produce, such as Mexico, Texas and Louisiana. It also stimulates more promiscuous consumption of energy.

The Bush administration comes out of the gulf war with new leverage over Saudi Arabia, Kuwait and the other Gulf emirates, which together produce more than half of OPEC's oil. As Robert Hormats, vice chairman of Goldman, Sachs, recently put it, "The U.S. is in effect the 14th member of OPEC now."

But the administration, so resolute in thwarting Saddam Hussein's threat to the oil supply, is now unsure how to use its new influence. The president knows that cheap oil will fuel a recovery, and hence his re-election. As a free-market man, he doesn't like the idea of intervening to influence prices. But as a one-time wildcatter, he also knows that too-cheap oil will devastate the domestic oil economy.

At the Geneva OPEC meeting, according to the trade publication "Energy Compass," the Algerian oil minister, Sadek Boussena, accused the Saudis of doing America's bidding by refusing to cut production. A Saudi official shot back, "If he knows what U.S. policy is on prices, I wish he would share that, because I haven't a clue."

In fact, the Reagan and Bush administrations have both been schizophrenic on the subject of oil price regulation. The Bush administration's recent energy-policy report was a paean to the forces of the free market. Yet throughout the 1980s, whenever the price of oil got too cheap, the United States has discreetly encouraged OPEC to shore it back up.

Journalist Edward Jay Epstein once observed that there really is no such thing as OPEC. Basically, OPEC is a fig leaf for Saudi Arabia, whose market power is what makes the cartel possible.

Ever since 1973, the Saudis' willingness to hike or cut production millions of barrels a day has substantially driven oil prices. However, since the Saudis are America's ally, it is presumed that their policies must be friendly to our interests. Thus, when the price of oil goes through the roof, we can get angry at bad "OPEC" rather than good Saudi Arabia.

Given the Saudis' implicit dependence on American protectorate for the past several decades, it is remarkable that they were able to get away with price-gouging as long as they did. Now that their dependence is explicit, the United States can make its influence felt. But to what end?

The administration would be wise to use its new leverage in the region, not just to broker peace between Israel and the Arabs, but also to sponsor a global system to stabilize the price and supply of oil, rather than leaving the job to the Saudis. The main obstacle is the administration's ideological pretense that oil supply and price can and should be set by free markets.

In fact, oil prices have never been set primarily by market forces. Ever since John D. Rockefeller created the Standard Oil trust, oil has been substantially controlled and priced by cartels. The Saudis are only the most recent managers of the cartel.

Volatile oil prices do real economic damage, both when the price is too high and when it is too low. An oil regime committed to stabilization of price and supply would mean a system of long-term contracts between producing nations and oil consumers, with explicit commitments by producers to adjust supplies in order to maintain target prices. In essence, it would mean explicit regulation, as opposed to the implicit regulation we have now.

America's economic prospects suddenly appear brighter thanks to cheap oil and falling interest rates. For that, the Bush administration can credit a combination of skill and luck.

Coming out of the Persian Gulf war, the administration seemingly holds all the cards. But everything will depend on how those cards are played.

Robert Kuttner writes regularly on economic matters.

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