Good Company

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Wednesday, September 26, 2007

Free market oil?

Some interesting thoughts on why our energy policy,based on "national security," may make very little sense here:
This is unfortunate, because the national-security rationale for energy policy is no more persuasive today than it was in the 1970s.

Do we need to spend billions and, if necessary, blood and treasure to defend oil producers in the Middle East? No. Oil producers will provide for their own security needs as long as the cost of doing so results in greater profits than equivalent investments could yield. Because Middle Eastern governments typically have nothing of value to trade except oil, they must secure and sell oil to remain viable. Given that their economies are so heavily dependent upon oil revenues, Middle Eastern governments have even more incentive than we do to worry about the security of production facilities, ports, and sea lanes.

In short, the U.S. oil mission is a taxpayer-financed gift to oil regimes that has little, if any, effect on oil prices. One may support or oppose such a gift, but it is not compelled by our need for foreign oil.

Do we need to “kiss the ring” of oil producers to ensure a steady supply of oil? No. Friendly relations with producer states neither enhance access to imported oil nor lower its price.

Selective embargoes by producer nations on some consuming nations are unenforceable unless (i) all other nations on Earth refuse to ship oil to the embargoed state, or (ii) a naval blockade were to prevent oil shipments into the ports of the embargoed state. That’s because once oil leaves the territory of a producer, market agents dictate where the oil goes, not agents of the producer, and anyone willing to pay the prevailing world crude oil price can have all he wants.

The 1973 Arab oil embargo is a perfect case in point. U.S. crude oil imports actually increased from 1.7 million barrels per day (mbd) in 1971 to 2.2 mbd in 1972, 3.2 mbd in 1973, and 3.5 mbd in 1974. The long gasoline lines and high prices that we associate with the embargo were triggered by with domestic price controls, rationing, and the oil-inventory buildup accompanying fears of a regional war in the Middle East — not the embargo.

Moreover, oil-producing nations have never allowed their feelings towards oil-consuming nations to affect their production decisions. After a detailed survey of the world oil market since the rise of OPEC, MIT professor M.A. Adelman concluded, “We look in vain for an example of a government that deliberately avoids a higher income. The self-serving declaration of an interested party is not evidence.” Prof. Philip Auerswald of George Mason University agrees; “For the past quarter century, the oil output decisions of Islamic Iran have been no more menacing or unpredictable than Canada’s or Norway’s.”

While it is possible that a radical oil-producing regime might play a game of chicken with consuming countries, producing countries are very dependent on oil revenue and have fewer degrees of freedom to maneuver than consuming countries. Catastrophic supply disruptions would harm producers more than consumers, which is why they are extremely unlikely.

If American dollars spent on foreign oil actually increased the fighting strength of Islamic terrorists, then one would expect to see a correlation between oil prices (a good stalking horse for oil profits) and Islamic terrorist activity. But there is no such correlation to be found. In a recent study, we estimated two regressions using annual data from 1983 to 2005: the first between fatalities resulting from cross-border Islamic terrorist attacks and Saudi oil prices and the second between the number of cross-border Islamic terrorist incidents and Saudi oil prices. In neither regression was the estimated coefficient on oil prices at all close to being significantly different from zero.

Hence, belief that cutting oil profits would cut Islamic terrorism is a matter of faith, not a matter of fact. Given the low-cost nature of terrorism (the 9/11 attacks, for instance, cost only about $500,000), there is little chance that anyone’s energy policy is going to bother al Qaeda very much. They seemed to do very well in the 1990s when oil prices — and thus, oil profits — were at their lowest level in the entire history of the oil age.
Simply put, there is absolutely no relationship between energy policy and national security. If Republican presidential candidates want to embrace the Reagan legacy, they can start by sounding like Reagan. And that means embracing free energy markets and not federal 10-or-25-year energy plans.

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