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Pearlstein

Business: Oil Prices

Steven Pearlstein
Washington Post Columnist
Wednesday, October 13, 2004; 11:00 AM

Washington Post business columnist Steven Pearlstein was online to talk about his latest column, in which he writes that "energy independence" has crept back into the national conversation. Pearlstein writes that without some miracle breakthrough like controlled fusion, energy independence is unattainable, probably undesirable and discussion of it avoids the real question of why the world continues to let the price of a crucial commodity be set at artificially high levels by a notorious cartel.

A transcript follows.

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About Pearlstein

Steven Pearlstein writes about business and the economy for The Washington Post. His columns on the economy appear every Wednesday and Friday.

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Manassas, Va.: This is one reason why pressing for a free market in oil won't work: US double standards. On one hand, it promotes (and sometimes forces) the benefits of free markets throughout the world; on the other hand, it closes its own markets to those very countries it preaches to.

How can the US be taken seriously with this double talk?

Steven Pearlstein: Not sure there is much evidence that our markets are so closed in a general sense, or even in the sense of energy markets.

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Columbia, Md.: I always thought this 'conservation' movement was OK, but not as good as confronting OPEC. I think we have to fight OPEC at all costs. Even if we have to open the ANWR, it would be worth the risk because it would finally break the grip (artificial and consenting) OPEC has on the world. Thanks for suggesting a novel idea, by Washington standards, that is. Your columns are a good read.

Steven Pearlstein: Thanks for the compliment. And you are right: confronting a price fixing cartel doesn't mean we shouldn't do other smart things like develop our our resources (offshoring drilling of natural gas, for example) or invest in new energy sources or even impose an energy tax on ourselves rather than allow the Saudis to extract the same amount in higher oil costs. Doing all these things would amount to what we used to call an energy policy.

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Atlanta: I don't agree with your premises. Supply is tight in the world - China and India are helping to drive up the prices, along with our gas guzzlers here in the US. Gas mileage has never been an issue with Americans and apparently, never will be. Instead, we would like to whine about prices.

In addition, no new refineries have opened up in many many years - so no matter how much more OPEC produces, or how low prices go, we CANNOT refine more than we do now - the refineries are at their peak as it is.

Also, each state has its own mix of gas for the environment, which makes it very expensive for the companies to sell oil/gas in each state - they have to pour over each state's regulations, which is tedious and costly.

Yes, I do think that OPEC doesn't play fairly and we have and keep doing a lot for them without asking for anything. We look the other way at state sponsored terrorism (still). But to think they should heed our regulatory environment and play by our economic rules is ridiculous - they have what we want and they can ask whatever they want for it, however they want to sell it to us - isn't that the American way, anyway?

Also, if you ever think our so called allies in Europe will ever side with us against the Arabs, you live in a dream world.

Steven Pearlstein: Well, you make a number of interesting points. But I think you fall into the trap of taking the "supply" of oil in the world right now as given. It could be a lot greater if the nations with most of the oil supply hadn't nationalized their industry, preventing free flow of goods and investment at market prices, like almost every other industry. That would have generated more investment and greater supply at market clearing prices lower than the OPEC target prices (to say nothing of today's market prices). That is my point here.

Yes, we also make mistakes in policy in this country: too restrictive policies on benign drilling, impossibility of siting any energy facilities, lack of tough efficiency and mileage standards, energy taxes that are too low to reflect the "social" costs of environmental degradation and resource depletion. That's all true. But it doesn't excuse ignoring notorious and market-distorting and economic-growth depressing price fixing.

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Rockville Md.: Is there an international organization that monitors OPEC and if not maybe the FBI or Justice Department could look into the price gouging ($20 to $>50/bbl). It appears our country is not only facing suicidal terrorists but greedy economic terrorists as well.

Steven Pearlstein: I like that: greedy economic terrorists. Its overstating it a bit but as political rhetoric, that's a nice contribution. Thanks.

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Laurel, Md.: I know gas taxes vary a lot by state, but could you estimate what $30 or $10/barrel translates to for a gallon of gas at the pump, given that $50/bbl=~$2.00/gal?

I assume the cost of refining, business overhead, distribution and exploration don't change much.

Steven Pearlstein: Can't answer your question, sorry. I'm not that much of petrogeek. But yes, the other costs other than crude don't change that much.

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Lyon, France: If the USA and the rest of the world continue to rely on oil from Arab-occupied nations with pro-terrorist governments, how long will it be until there is a true energy crisis and supply is unavailable?

Steven Pearlstein: As you may have noticed, I stayed away from the OPEC terrorist link. But I think the evidence is pretty clear that, to the extent excess oil profits have wound up financing Muslim fundamentalists who target oil pipelines and refineries, there is a certain irony -- and risk to oil price stability in the short term, in any case.

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Silver Spring, Md.: You might want to spell out the difference between marginal and average cost.

The marginal cost of providing the oil to meet the last increment of demand, given increased worldwide demand and some supply disruptions, is high. The average cost of production remains low. In any market, that means that low-cost producers are going to earn profits.

This is not a conspiratorial issue, however. It is not the OPEC got greedier, it is that the market moved to the benefit of low-cost producers.

It is bad economics to attribute to greed what in fact is just market forces at work.

Steven Pearlstein: As someone who spent a lot of years as an economics and business writer, I don't make a habit of criticizing people for being greedy: greed is what free markets are all about, or, more politely put, maximizing your own income, which amounts to the same thing. But I'm not sure I get your point. OPEC nations, individually and collectively, manipulate the market in this one vital commodity to restrict supply and put a floor under prices, and for most of the last 30 years they have succeeded in that. The market has NOT worked the way you say, which is to have the low cost producer use his advantage to drive the high cost producer out of business and gain more market share and profit. The price has not declined to the marginal cost of production. That's the problem.

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Rockville, Md.: The facts in today's column are correct, but the conclusion is wrong! A free, global market in crude and refined oil will only increase our dependency on oil and those that produce it; will result in more of the same pollution; will discourage investment and research into more sustainable energy sources such as wind and solar. A long-term fix to the world's oil addiction is to tax energy suppliers and users so we can fund alternatives.

Steven Pearlstein: This is the standard environmentalist line and there is a lot of merit to it. But I part company with you on the idea that its a good idea, economically, to have OPEC and other producers impose an energy "tax" on us. If we want to raise the consumer price of energy in order to achieve environmental goals, then it would be better for the U.S. government to impose it and enjoy the revenues, to be used for all sorts of worthy public purposes, including investing in new energy sources. And this notion of "oil addiction" is just nonsense. Are we "addicted" to capital? To telephone calling? Oil is a useful input into goods and services that we value, which is why we use it. The idea that it is all "bad" for us is silly. Life is complicated and it involves tradeoffs, which is something, alas, that the environmental movement stubbornly refuses to acknowledge.

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Rockville, Md.: Do you know what our Dept Of Energy is doing, if anything, to reduce our dependence on oil as the major source of energy we use?

Steven Pearlstein: Why is it a good thing to reduce our dependence on oil, if we could get the oil priced correctly? Is dependence on nuclear power better? Or ethanol? Why? We need energy, which means we will be dependent on energy sources. So why not let free markets determine point at which supply and demand reach some sort of equilibrium? And just because the oil is foreign isn't necessarily a bad thing. Do we need a national policy to reduce our dependency on foreign television sets and athletic shoes? I don't think so. Why is oil any different, after allowing for a strategic reserve to handle our defense needs in time of war?

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Bowie, Md.: Pump prices have approximately doubled (from one dollar to two per gallon) since 1998 when Exxon merged with Mobil, followed by Chevron/Texaco and BP/Amoco.

What role has this lack of competition played in setting either wholesale or retail prices?

Steven Pearlstein: This is a complicated and contentious issue. Let me share with you an educated hunch. The Federal Trade Commission has reviewed all these mergers, during the Clinton and the Bush administrations, and generally allowed them to proceed, albeit with some significant divestitures. The folks at the FTC do the usual antitrust analysis, breaking down the oil market into regional and product submarkets and determining the number of competitors and the degree of competition. And in general, these analysis have yielded a conclusion that the mergers are not harmful.

I think the problem is that these regulators don't take a step back and consider what happens when, at one end of the value chain, you have a group of national oil companies conspiring to limit investment, limit supply and control prices. And in that context, you've had some perverse things happen which have caused the major oil companies, with all their money and power, to move their attention and investment to those portions of the business that enjoy the monopoly profits that flow from OPEC market manipulation. And what that has meant is that they have retreated, in a big way, from refining and marketing, particularly in submarkets where there is "too much" competition and profit margins are what they are in ordinary industries. And through this retreat the disinvestment, they have contributed significantly to supply bottlenecks that in other industries might be solved by having other companies or new companies enter the market. But entry is virtually impossible in this industry, and in fact the number of possible competitors keeps going down as a result of mergers. So while the antitrust geeks might be able to conclude, based on their fine grained analysis, that any one merger is benign, or can be made benign through selected divestiture, my hunch is that the longterm, overall effect of this consolidation is to increase the extent and degree of oliogolopolistic behavior, where companies don't engage in the kind of bare-knuck competition for market share, including price wars, that you'd expect in a commodity business. One signal of this is the total lack of longterm supply contracts in this industry. Another is to see what happens when Wal-Mart and the hypermarkets come into an area and gain market share by offering lower price. The majors in those cases don't respond by lowering their own prices very much. They give up market share rather than accept lower profit margins. And that should be a signal, even to the antitrust geeks, that the market structure they allowed exhibits less than competitive behavior.

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Silver Spring, Md.: If governments are guilty of forcing up prices by restricting drilling, is the United States guilty by restricting drilling in ANWR? If so, then why is it the Bush Administration, which supposedly is friendly the oil companies, that is pushing for drilling?

Steven Pearlstein: The only reason to prevent drilling in ANWR is that the environmental harm would outweigh the economic benefit. Some people believe that. I don't.

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Silver Spring, Md.: When you say that OPEC has lost control and prices are being set by market forces, that tells me that the marginal cost, even for OPEC, is over $50 a barrel.

Yes, they could invest in more capacity, but right now, $50 is the marginal cost.

Steven Pearlstein: No, $50 is not the marginal cost. First of all, that is a futures price that reflects short term market psychology. It is also a reflection of the fact that there has been a noticeable increase in demand for oil in the last year, thanks to China and an improving world economy, without a concomitant increase in available supply. But that supply, as I have argued, is artificially constrained by OPEC and other producing countries.

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Forest Hills, N.Y.: Some would argue that oil is different than other commodities, because of its indirect impacts. The Middle East supplies a large portion of oil, the U.S. and the rest of the world supports the oppressive, backwards regimes that run those countries with their oil purchases, these regimes enrich themselves while paying little attention to their people, and some of these people (with a volatile mix of Muslim fundamentalism) become terrorists. The same cannot be said of shoes made in Vietnam or ethanol made in Iowa.

Steven Pearlstein: All those are valid points. But I'm not sure where they lead. Columbia and Afghanistan dominate the cocaine market and they use their monopoly profits in bad ways, too.

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Washington, D.C.: A few people have suggested that some Muslim nations with oil are engaging in economic terrorism. I subscribe to the belief that the public will see a steady diet of violence from the media about how governments who control vast oil reserves are also harboring terrorists and must be toppled -- by the United States. Do you believe that the War on Terrorism and Iraq Invasion could just be oil wars?

Steven Pearlstein: I don't believe the country went to war in Iraq for oil reasons. Nor do I believe that was some secret motive of the Bush administration.

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So why do we subsidize?: The part of what you are writing misses is that we subsidize the primary users of oil. Roads are now paid for mostly via general taxation. Auto companies get huge tax breaks. Suburban sprawl gets local and state subsidies (and drives demand for more subsidized roads).

So complaining about supply issues is a joke on its own. Being an urbanite, I'm sick and tired of being the cash cow for the SUV a'drivin exurbanites, and eating long commutes to Herndon because businesses chase the cheap subsidized rents. Fix both (which means of course that gas would still cost more than it does right now).

Steven Pearlstein: This is mostly environmental propaganda. Roads are a rather important public good that help makes our a very efficient economy. They are not something private markets are very good at providing in most instances. So we do it collectively by raising taxes. As it happens, I believe most of the money for roads comes from gas taxes, which means a user tax, which is just what good environmental and public finance policy dictates. And to talk about all the tax breaks that go to auto companies is simply nonsense -- unfortunately, we give tax breaks to just about all big corporations. It's also just not true that suburban sprawl gets lots of subsidies. Americans like to live in suburban housing and they are willing to pay for it in money and commuting time. They are not being driven to it unknowingly by hidden subsidies. You don't like that for aethetic or environmental reasons and you'd like the government to use its powers to "punish" them and "subsidize" the kind of urban lifestyles you prefer. But I think the evidence shows is that the urban sprawlers pay their way over the long run.

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Effect of oil prices on gas prices: A recent article quoted an energy economist as saying that an increase of "$5 to $6 a barrel to the price of oil [is] roughly the equivalent of about 14 cents per gallon for motorists." If that's accurate, a $1 increase in oil price would result in gas prices increasing by something like 2-3 cents per gallon.

Steven Pearlstein: Thanks.

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Steven Pearlstein: Thanks, folks. Was expecting to get hectored this morning by the army of oil experts with all sorts of data showing that it is really this or that that causes oil prices to be too high. I got a number of private emails this morning from people who accused me of not understanding the oil market, which I'm sure I don't fully understand. What I wrote back to these folks was that the implication of what they were telling me was that price-fixing and state control in the oil industry were actually a good thing and had done nothing to increase the price of this commodity above what would happen in a truly free and open market. Nobody wrote back defending state control and price fixing -- at least not yet.

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