World governments have collectively poured trillions of dollars of stimulative spending into the world economy since the crash of 2008. And, they've shoveled trillions more into failed financial institutions. In addition, several of the world's central banks have lowered short-term interest rates so low that the next move would have to be negative. Still, the world economy remains weak despite unprecedented measures to stimulate growth.
And so, global leaders are now implementing another stimulative measure that they hope will prevent the economy from teetering over into recession once again: lowering oil prices through the coordinated release of 60 million barrels of oil into the market from government-run strategic petroleum reserves. The move seemed to have the desired effect as oil prices fell more than 5 percent after the announcement.
The question is: Why did global leaders wait until now? The Libyan conflict had already caused the loss of more than 1 million barrels of oil per day by the end of February. As a result, oil prices soared above $120 per barrel for Brent Crude. Yet, countries holding emergency stocks did nothing at the time. But now, with government budgets across Europe and in the United States moving toward austerity and with the U.S. Federal Reserve ending its second round of so-called quantitative easing--a bond buying binge designed to bring down long-term interest rates--world leaders have one last card to play. They have a vast supply of petroleum that will now be used to bring oil prices down and thus allow consumers of oil products to pocket the savings and spend that savings on other things in the economy.
Two questions come to mind: Will it work? Will it have any side effects? Let's take the first question. Undoubtedly, it will work. It already has worked at bringing down the price of crude. Price is a function of supply and demand. We have just increased the supply substantially. But, since the release is only scheduled to take place over the next month, the follow-on question is: What next? If the economy doesn't stabilize, will the powers-that-be try another release? While this current release is relatively small, continued releases could begin to erode the emergency protection function of strategic petroleum reserves. And, further releases would only highlight the tightness of the crude market and might actually embolden speculators to push up the price. It is a tricky game to shape expectations in markets through which hundreds of billions of dollars flow each month.
Now for the second question: Will the release have any side effects? What we actually need to be doing is discouraging wasteful energy use. Manipulating the price downward actually encourages consumption. And, that's exactly what we see in such countries as Saudi Arabia and Venezuela where gasoline is heavily subsidized. (A recent survey showed prices in Saudi Arabia at 61 cents per gallon, and prices in Venezuela at 8 cents per gallon.) This is precisely the wrong incentive in an era of tightening supplies. This intervention also discourages exploration by adding yet another destabilizing element to the energy markets. It's hard enough for oil and gas companies to determine which prospects will be profitable without having to contend with the possibility that prices will unexpectedly be knocked down through government action.
The truth is that oil prices have long been manipulated for specific policy objectives. For most of the 20th century the United States was the world's preeminent oil power and the world's swing producer. And, Texas was the place in the world with the most excess capacity to produce oil. (A swing producer can quickly increase or decrease production in order to bring prices up or down as desired.) Before 1970 the Texas Railroad Commission, which regulates oil and gas production in the state, managed world oil prices by deciding what percentage of a well's maximum output could be produced. (Since that year, wells in Texas have been allowed to run at 100 percent of capacity.)
Later as the United States became an oil importer, Saudi Arabia built up considerable excess capacity and became the world's swing producer. The trouble is that today no one--not even the Saudis--has enough spare capacity to act in that role and moderate oil prices. We know this because the Saudis have not been able to do much to offset the loss of oil production in Libya earlier this year. Instead, the Saudi oil ministry kept insisting that the world was well-supplied even as prices for Brent crude rose above $120 a barrel.
Now, the world's strategic petroleum reserves have temporarily taken on a role formerly filled by the Texas Railroad Commission and Saudi Arabia. But with no real production capacity, the world's holders of such reserves are merely draining away their rainy day fund of fuel in what is likely to turn out to be a futile effort to manipulate the oil markets and save the economy from another steep decline.
The high price of oil isn't, of course, the only thing troubling the economy. If all the heroic financial measures that have been tried to date are not creating the desired self-reinforcing recovery in the world economy, then the attempt by governments to lower world oil prices must be seen as nothing more than a Hail Mary pass with little chance of success.
By. Kurt Cobb
Source: Resource Insights