The Best Energy Policy Is No Energy Policy

March 13, 2000 • Commentary
Reprinted from the Wall Street Journal © 2000 Dow Jones & Company, Inc. All rights reserved.

After disappearing for a couple of decades, the Organization of Petroleum Exporting Countries (OPEC) is back with a vengeance. The cartel that time forgot has rediscovered its economic muscle and has driven up oil prices to $30 a barrel and climbing. Democrats and Republicans are likewise returning to the politics of the energy crisis, demanding that government bring down prices. But before we dust off the policy playbook of the Carter era, we should recall the lessons learned the last time around. Unfortunately, too much has been forgotten by politicians in both parties.

First, jawboning OPEC heads of state (the political euphemism for begging OPEC to increase production) is at best a waste of time and at worst a sucker’s game. It has never worked before and will not work in the future because cartel members are profit maximizers, and production decisions are determined by financial considerations. No matter what the cartel says to gullible Western officials, nothing ever has changed and nothing ever will change that fundamental calculus.

Second, trying to convince OPEC that it’s in the cartel’s best interest to head off a global recession — and thus, that it’s in the cartel’s best interest to increase oil production — is premised on wishful thinking. OPEC members are almost entirely dependent on the oil trade. They have little other economic business with the rest of the world. Global recession need not concern them as long as oil profits remain robust. The recessions of 1974 and 1979 demonstrate that OPEC can make a lot of money during economic hard times, a lesson not lost on the cartel.

Third, investigating “big oil” for price gouging is counterproductive. In the 1970s, those suspicions were stoked by stories of oil tankers lingering offshore, presumably waiting for prices to go up before they unloaded their cargo. True … sort of. Tankers were indeed lingering offshore, but it was because docks were overloaded with cargo and ships had to wait days or even weeks to unload. “Big oil” — then and now — is guilty only of passing its increased costs on to consumers instead of selling at a loss.

Political saber rattling about the alleged profiteering of “big oil” actually makes the crisis worse. That’s because the only hedge against supply disruptions in the near term is inventories. But inventories are costly to maintain. If companies can’t cash them in at a profit during price run‐​ups because they fear criminal investigations or the imposition of “windfall profit” taxes, companies won’t bother maintaining inventories in the first place. That is indeed the case today, and the upshot is that oil price spikes are far steeper than they need to be thanks to all this political demagoguery.

Ironically, that’s the logic behind the Strategic Petroleum Reserve (SPR). Politicians, alarmed that oil companies don’t keep large stockpiles of oil on hand, decided that the government must do what the private sector won’t. But the very existence of the SPR makes it even more certain that companies won’t stockpile. They never know if or when government might flood the market with federal oil, dropping prices and preventing them from making a profit from their inventories.

Unfortunately, the SPR is a poor substitute for private inventories. Because the decision about whether to release oil to the market is made by politicians, the decision to release or not to release is based on political, not economic, criteria. The result is that the SPR has never once helped the economy through a price spike, probably never will, and eats up billions of tax dollars in the course of not helping.

Fourth, “energy independence” is a mirage. It does not matter whether our oil comes from Texas or Saudi Arabia. Oil prices are determined by global supply and demand factors, so production cutbacks in the Persian Gulf will increase the price of Texas crude as much as that of Saudi crude. “Energy independence” sounds nice, but it’s a political gesture, not a serious policy.

Finally, government should forget about trying to control oil prices. First, it can’t. The forces of global supply and demand are effectively out of the administration’s control. Second, it would do more harm than good. Prices are important signals about relative scarcity and expectations about the future, and federal intervention to distort prices would send inaccurate signals to consumers and thus harm, not help, the economy. Third, it has no business doing so. You can read the Constitution backwards and forwards and find nothing in it empowering the government to manipulate prices.

Happily, some of the worst ideas of the 1970s — energy price controls, gasoline rationing, windfall profit taxes, micromanagement of consumption decisions and white elephant investments in “wonder fuels” — are more or less off the political table. But both George W. Bush and Bill Clinton are building an energy strategy on the same nonsensical foundation — jawboning, self‐​delusion and economic illiteracy.

The best energy policy is no energy policy. Oil is like any other commodity. Although the economy reacts sluggishly to petroleum price signals (demand is “inelastic” in the short term), it does react. High prices will encourage new production, more efficient consumption and alternative fuel use.

We should hold tight and wait OPEC out. The invisible hand will moderate prices. High oil prices will increasingly tempt OPEC members to cheat on their production quotas, a temptation that will become too great to resist at some point. Think of the OPEC cartel as a dam that attempts to hold back a mighty river. The more successful the dam, the greater the pressure working to break it. We also know that the river (oil supply) is growing larger, not smaller. The dam cannot hold. Let’s not do anything foolish in the meantime.

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