3rd April 2012
The current rhetoric on oil prices suggests that policymakers have the power to raise and lower prices as they desire. The Republicans suggest that President Obama can – and should – lower prices by using strategic reserves or additional drilling. Other commentators suggest that it is central bank policy that has created the rise in oil prices. But do policymakers really have as much power as this would suggest?
The oil price is quickly becoming a political hot potato in the US . The Republicans have accused Obama "of tying up energy projects in red tape and not doing enough to open areas for drilling." Obama, for his part, has said that the latest spike in oil prices was "mostly due to Middle East unrest and touted his "all of the above" energy strategy of boosting domestic production and investing in green energy as longer-term solutions.
"He ridiculed Republican presidential candidate Newt Gingrich's campaign promise to reduce the price of gas to $2.50 a gallon if he won the White House, calling it just a "cute bumper-sticker line."
The view that policymakers are in control of the oil price is widely supported. For example, on Zerohedge , commenter CrownThomas attributes high oil prices to central bankers' policy of pursuing inflation : "The price of a barrel of oil is now soaring above $100 a barrel; just as it always has done when the Fed has gone on one of their counterfeiting sprees. And it's not just dollars that have been eroding in value because the price of oil in Euros is now at a record high. The sad truth is that with each iteration of QE, either in the U.S. or around the globe, it has sent oil prices skyrocketing, inflation rising and the economy into the tank."
Even many oil speculators support the belief that policymakers can manipulate the price of oil in the short-term: "Crude futures fell about 1 percent, weighed by the possible release of strategic oil reserves by the U.S. and European nations. Oil prices are up 7.8 percent this year on Middle East tensions, and high prices could threaten an economic recovery.
"The one thing that can derail this recovery is a spike in oil prices from these levels, and a release of reserves would signal that the government stands ready to take action to bring prices back down," said Oliver Pursche, president at Gary Goldberg Financial Services in Suffern, New York."
But is this really the case? Martin Woolf argues in the Financial Times , that there is little Obama can do to bring down gas prices: Mr Obama said: "We are drilling more. We are producing more. But the fact is, producing more oil at home isn't enough to bring gas prices down overnight." These remarks are correct, except for the last word. Producing more oil would have next to no effect on oil prices."
He adds: "In the longer run, a big reduction in US demand, still 20 per cent of the world's total, might make an appreciable difference to prices. Moreover, the relative wastefulness of US oil use, compared with other high-income countries, would make such a reduction quite easy to achieve. The best way to make this happen would be to raise prices, via higher taxation. But that policy is deemed un-American."
A letter-writer into the FT agreed:
"This is just one more commodity price cycle of high prices driving new supplies and weak demand, followed by excess supply, falling prices and a return of demand growth driving prices back up. We have been through this five times in the last 40 years with little apparent learning. The big problem is that this will both confuse energy policy and, especially, make climate change policy much harder."
Tom Nelson, an energy specialist fund manager at Guinness Asset Management, says: "We have seen OPEC find it extremely difficult to achieve their targets of $90-$95 for the oil price. Any discussion of what governments can or can't do to deal with a higher oil price needs to be set in that context. Policymakers can do a certain amount to quell consumer fears in the short-term – by decreasing taxes in developed markets or increasing subsidies in emerging markets. This may lessen the pain for the buyer at the pump, but over the longer-term I would question the ability of any government to effect material change on the oil price."
He believes that there are far longer trends at work in the oil price – notably the growth of non-OECD demand for oil. There is also a natural equilibrium. Once it gets to beyond 5-5.5% of global GDP, he suggests, there can be a dramatic effect on demand behaviour. This was seen most significantly in the Arab/Israeli war of 1973 to 1975 and during the fall of the Iranian Shah in 1979.
Perversely, suggests Woolf, the one area where policymakers may have a real effect is in imposing sanctions in Iran: "If there is a specific cause for the rise in oil prices, it is the tightening of sanctions on Iran, which Republicans support. If, as many desire, military action is taken, the impact on oil prices and the world economy will be far greater."
Therefore, for all the rhetoric on higher oil prices and the action policymakers should be taking, it is unlikely that policymakers' actions to increase supply will have any significant effect. Ultimately policymakers cannot manipulate the longer-term profound trends in global energy supply.
More on Mindful Money
To receive our free email newsletter sign up here