Over the decades that the Organization of Petroleum Exporting Countries (OPEC) has been in business, we’ve come to view them as a benign player on the world stage.  They are anything but.  We have forgotten, if we ever knew, that they are group of “outlaw” nations that engage in behavior that would be illegal in most countries, at least in the West.  This is because it is not legal in most Western nations to conspire to keep prices artificially high.  It’s called restraint of trade among other things.  It is the essence of OPEC. 

I’ve been watching and observing OPEC for most of my lifetime.  It was founded in 1965 when I was eleven.  In my college years, studying natural resources economics at university, I watched OPEC play a key role in the oil crisis of the 1970s.  I recall experts predicting that the price of oil would only continue to increase in the years ahead.  I was amused last year as oil prices rose to record levels that experts were predicting once again nothing but higher prices for oil on into the future.  My reaction this time was, ‘well maybe, but it would be a first’.  It would be a first because over the 30 years that I’ve been watching the oil business I’ve observed that while the behavior of OPEC in reducing supply can result in high prices for a time, the market always wins in the end.  Every time prices get too high for too long, new investments are made and new technologies are employed to develop oil fields that, but for the higher prices, would have been uneconomic.  The new oil flooding the market causes a massive decline in oil prices.  This in turn triggers OPEC to take measures to restrict supply so as to again drive up the price of oil.  

That is in essence what OPEC has done yet again this week.  As reported in yesterday’s New York Times in the story Further Cuts In Output By OPEC Are Likely, OPEC is preparing yet again to cut oil supply in an attempt to drive up the price of oil.  This is notwithstanding the “dire state of the global economy” as the New York Times story put it.  You see, this doesn’t matter to OPEC.  What matters is maximizing the return from their production.

When oil prices rise again, as they will do, OPEC will be only one of the reasons.  Another reason is that low oil prices will have meant that oil companies will have cut back on their investment in new production.  Another New York Times story explains this phenomena.  It’s entitled Big Oil Projects Put in Jeopardy by Fall in Prices.  At today’s prices (the Times reports New York oil futures at $43.60 a barrel on Tuesday), oil companies can’t invest in new production and still make money.  With no investment, supply will fall, and sooner or later, in concert with the actions of OPEC to reduce supply, equilibrium will once again be reached and then breached as demand once again outpaces supply and the price climbs.

For now, the world economy gets a break.  It will be awhile before the OPEC actions and the impact of declining investment in new production begin to show in the market in the form of higher prices.  The world economic slump and its impact on the demand for oil could prolong this period.  In the meantime, every month the price remains low is stimulus to the world economy for which we can be grateful.  Imagine how bad things would have been if the world were still paying last year’s prices for oil.         

The longer term problem is that the oil price yo-yo does no one any good.  Stability in oil prices would be a far better for the world’s economies over the long term.  Industries could plan and consumers could make decisions rationally.  Now, it is anyone’s guess especially as traders collude and world events throw uncertainty into the equation.  How could this situation be improved?

I’d argue that at least in America, an ever-increasing floor on the price of oil (in essence a tax on oil), would contribute to price stability.  It would help send a market signal to consumers that conservation of oil is a good thing.  It would send the signal to Detroit that more efficient cars are an economic necessity.  It would signal to all American energy producers–oil and natural gas production companies as well as solar, wind and geothermal companies–that investments made will be able to be recouped.  It would also begin to address our overuse of carbon-based fuels and begin to cut our emission of CO2 in the atmosphere even in advance of passage of complex cap-in-trade legislation.  If implemented so that all government revenues received from the tax were refunded to consumers, it would be largely tax neutral and should not negatively impact economic recovery, indeed it would assure that the recovery that takes place is smarter from an energy conservation perspective.  See my posting entitled A Floor on Oil Prices and its reference to an excellent Washington Post editorial on the subject. 

I’d argue that imposition of the tax (via setting a floor on the price of oil) along with a meaningful opening of U.S. offshore resources to development and a responsible policy of onshore leasing on federal lands in the west would insulate political Washington and particularly the Obama administration from the shock of higher oil and natural gas which can be expected to hit the U.S. economy just about the time of the next general election in two years.  It would be both smart politics and the right thing to do.