Economist and writer Edward Lotterman publishes this insightful op-ed in which he makes the case that OPEC’s threats of curtailing oil production do not merit much hand-wringing. He points out the following:
Ignoring inflation, world crude prices and U.S. domestic gasoline prices are at or near record levels. Fuel prices are becoming an issue in the U.S. presidential campaign. Some forecasters worry higher energy prices will stunt U.S. economic growth. Others fear it will fuel inflation, leading the Fed to constrict the money supply earlier than it might otherwise.
Such concerns are understandable, and, to some immediate extent, justified. But much dramatic hand-ringing is highly overdone.
OPEC has great pricing power in the short run, particularly when world demand or political uncertainty are high. In the longer run however, it is a paper tiger. Over any time horizon longer than a couple of years, OPEC needs oil customers more than oil consumers need OPEC. We need to be sure that short-term pinches, such as the current one, do not seduce us into longer-term policies that will prove to be self-destructive.
After discussing the concept of elasticity of demand, Mr. Lotterman keys in on the key consideration regarding demand for oil:
[I]f demand is inelastic and you raise prices, you raise the total dollar value of your sales. If elastic, raising prices cuts such total revenue. The demand for oil is very inelastic in the short run, but much more elastic in the long run.
And then Mr. Lotterman concludes brilliantly:
OPEC economists are well aware of consumer behavior. They also know that they control less than half of global crude output and that every time they act to hold short-term prices above the mid-$20-per-barrel range, they lose market share to non-OPEC members and to natural gas ? and such losses often are permanent.
No one studies elasticities of demand for oil more than OPEC. Its leaders know that in the very short term ? i.e., a few weeks or months ? a 10 percent price hike may cut their sales only 1 percent or less. But in the long term, price hikes cut OPEC member nation revenues.
If OPEC had any real long-term pricing power, the value of member-nation oil reserves would grow. They have not. If Saudi Arabia, for example, has sold a billion barrels of its reserves to someone else in 1974 or 1981 and put that money into U.S. Treasury bonds, they would have much more money today than the value of the same billion barrels at 2004 prices.
Alarmists always retort, “Yes, but it is different now; this time they really have us over a barrel.” They are mistaken. As technology matures and alternative sources of energy come into play, the importance of oil will fade.
A century from now, there will still be billions of barrels of crude lying unpumped beneath the sands of the Middle East just as there still are large quantities of copper in Montana and Arizona. Like such copper, the oil simply won’t be worth pumping because no one will be willing to pay much for it.
Nor should we worry unduly about maintaining dutifully friendly regimes in the Middle East or even Venezuela.
Countries like Saudi Arabia, Iraq and Iran have little going for themselves beside oil. Cutting off shipments to punish the United States or other industrialized countries would damage their own interests much more than those of anyone else.
Oil is an extremely fungible product. What matters is global supply and global demand. Blocking flows between any two particular countries or sets of countries is meaningless except in the very short run. Don’t lose any sleep over this issue.
Not only should we not lose any sleep over this issue, our demagogue antenna should spring to life immediately whenever we hear a politician attempt to make this an issue in this political season.