Economics Veto Politics in Prices

The reaction of financial markets to hints from Saudi Arabia that it will support a hike in the oil price--perhaps as much as $3 a barrel--was understandable but just a little overdone.

Bond prices and most stock prices tumbled, although stocks of oil and oil drilling companies rose, as though energy prices would set off general inflation. But such fears are unrealistic.

The true outlook after the Organization of Petroleum Exporting Countries’ recent meeting in Vienna and the curious behavior of Saudi Arabia is that oil may rise somewhat this summer but won’t be able to sustain an increase of $3 a barrel, or roughly 8 cents per gallon of gas.

If we understand the economic and political forces at work in the world oil market, we can be smarter--at the gas pump and in our investments--about sudden shifts in the Middle East and elsewhere.

Before Tuesday’s flurry, oil and gasoline prices were already on the high side, the result of economic recovery becoming more evident in the United States and economic well-being breaking out in hitherto underdeveloped places. China, India and Southeast Asia are growing rapidly and increasing usage of oil and natural gas; some countries in Eastern Europe are substituting oil or gas for heavily polluting lignite or brown coal.

It all adds up to global oil demand of 67 million barrels a day being nearly in balance with production. So the oil price may average out at about $20 a barrel this year--below current levels--and drift down a bit next year, said analyst Paul Mlotok of the Morgan Stanley investment firm.

But politically the story is more intriguing. OPEC’s decision to try to hold up prices indicates that the cartel believes that President Bush’s election campaign won’t be troubled by a firm oil price, Middle East experts say. “Saudi Arabia wouldn’t do anything to upset Bush,” one says.

But the Saudis, who produce 12% of the world’s petroleum, are leading a fight against European governments that are trying to impose a $3 per barrel tax on oil.

The Europeans, invoking environmental virtue, call their idea a “carbon tax” to combat global warming. But Arab states and Iran smell hypocrisy. They know that the oil they sell on world markets at $20 a barrel is the equivalent of 60 cents a gallon in gasoline or heating oil. But European nations have long sold that gasoline and heating oil at the equivalent of $4 to $5 a gallon, with much of the difference being tax.

To the oil producers, Europe’s carbon tax is one more attempt to finance a higher standard of living by taxing products of the developing world. “Such taxes are how European nations finance national health programs while our people live with poverty and disease,” an Egyptian government official says angrily.

OPEC’s hope is that its attempt to boost prices will cool European enthusiasm for a tax hike. “The truth is, oil today has become a standoff between organized sellers and organized buyers--an oligopoly and an oligopsony,” says Joseph Tovey of Tovey & Co., a New York investment firm specializing in energy issues.

And the trends favor the buyers because of the enormous supplies of oil in the world. There is overcapacity within the 13 OPEC member nations, particularly in Saudi Arabia’s still-growing reserves.

Uncounted in the OPEC figures that so scared markets Tuesday is the oil that Iraq’s Saddam Hussein is smuggling out to world markets by truck into Jordan. Some estimates put the amount at half a million barrels a day, worth about $10 million a day to the Iraqi dictator’s regime.

And if Saddam Hussein left the scene and embargoes against his country were lifted, Iraq would produce more oil. Its reserves are believed to be second only to those of Saudi Arabia.

New oil deposits are being defined in the newly independent states of the old Soviet Union. The Tengiz field in Kazakhstan, being developed by Chevron, is said to be as large as Alaska’s North Slope.

Finally, China--now an oil producer as large as Britain--and Vietnam are certain to increase their output of oil and gas as demand grows in Asia.

There will be work worldwide for oil drilling companies and outlets for the know-how of U.S. oil companies.

Keep two basic facts in mind when considering oil and inflation. One, the major oil producing regions are filled with ominous political currents. For example, Saudi Arabia and Iran are vying for political influence in the heavily Islamic and oil-bearing republics of the old Soviet Union--Azerbaijan, Kazakhstan, Uzbekistan and others.

But overwhelming oil supplies and the growing number of different producers offset political worries. The economics argue for lower prices.