The Best Energy Policy Is No Energy Policy

Reprinted from the Wall Street Journal © 2000 Dow Jones & Company, Inc. All rights reserved.
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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 forbeggingOPEC to increase production) is at best a waste of time and at worst asucker's game. It has never worked before and will not work in the futurebecause cartel members are profit maximizers, and production decisions aredetermined by financial considerations. No matter what the cartel says togullible Western officials, nothing ever has changed and nothing ever willchange that fundamental calculus.

Second, trying to convince OPEC that it's in the cartel's bestinterest tohead off a global recession -- and thus, that it's in the cartel's bestinterest to increase oil production -- is premised on wishful thinking.OPEC members are almost entirely dependent on the oil trade. They havelittle other economic business with the rest of the world. Global recessionneed not concern them as long as oil profits remain robust. The recessionsof 1974 and 1979 demonstrate that OPEC can make a lot of money duringeconomic hard times, a lesson not lost on the cartel.

Third, investigating "big oil" for price gouging iscounterproductive. Inthe 1970s, those suspicions were stoked by stories of oil tankers lingeringoffshore, presumably waiting for prices to go up before they unloaded theircargo. True … sort of. Tankers were indeed lingering offshore, but it wasbecause docks were overloaded with cargo and ships had to wait days or evenweeks to unload. "Big oil" -- then and now -- is guilty only of passing itsincreased 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 againstsupply disruptions in the near term is inventories. But inventories arecostly to maintain. If companies can't cash them in at a profit duringprice run-ups because they fear criminal investigations or the imposition of"windfall profit" taxes, companies won't bother maintaining inventories inthe first place. That is indeed the case today, and the upshot is that oilprice spikes are far steeper than they need to be thanks to all thispolitical demagoguery.

Ironically, that's the logic behind the Strategic Petroleum Reserve(SPR).Politicians, alarmed that oil companies don't keep large stockpiles of oilon 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 companieswon't stockpile. They never know if or when government might flood themarket with federal oil, dropping prices and preventing them from making aprofit 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 bypoliticians, the decision to release or not to release is based onpolitical, not economic, criteria. The result is that the SPR has neveronce helped the economy through a price spike, probably never will, and eatsup billions of tax dollars in the course of not helping.

Fourth, "energy independence" is a mirage. It does not matterwhether ouroil comes from Texas or Saudi Arabia. Oil prices are determined by globalsupply and demand factors, so production cutbacks in the Persian Gulf willincrease the price of Texas crude as much as that of Saudi crude. "Energyindependence" sounds nice, but it's a political gesture, not a seriouspolicy.

Finally, government should forget about trying to control oilprices.First, it can't. The forces of global supply and demand are effectively outof the administration's control. Second, it would do more harm than good.Prices are important signals about relative scarcity and expectations aboutthe future, and federal intervention to distort prices would send inaccuratesignals to consumers and thus harm, not help, the economy. Third, it has nobusiness doing so. You can read the Constitution backwards and forwards andfind nothing in it empowering the government to manipulate prices.

Happily, some of the worst ideas of the 1970s -- energy pricecontrols,gasoline rationing, windfall profit taxes, micromanagement of consumptiondecisions and white elephant investments in "wonder fuels" -- are more orless off the political table. But both George W. Bush and Bill Clinton arebuilding 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 othercommodity. Although the economy reacts sluggishly to petroleum pricesignals (demand is "inelastic" in the short term), it does react. Highprices will encourage new production, more efficient consumption andalternative fuel use.

We should hold tight and wait OPEC out. The invisible hand will moderateprices. High oil prices will increasingly tempt OPEC members to cheat ontheir production quotas, a temptation that will become too great to resistat some point. Think of the OPEC cartel as a dam that attempts to hold backa mighty river. The more successful the dam, the greater the pressureworking to break it. We also know that the river (oil supply) is growinglarger, not smaller. The dam cannot hold. Let's not do anything foolish inthe meantime.