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Should OPEC Reduce the Price of Oil

By Nader Habibi


Summary: By keeping the price of oil high OPEC will encourage a more efficient pattern of oil consumption in the United States. Since the United States has refused to sign the Kyoto treaty, it is neglecting its international duty to help prevent global warming. By forcing the United States to becoming a more efficient oil consumer, OPEC is indirectly contributing to the fight against global warming. 


Up until year 2000 the primary objective of OPEC cartel was to prevent a decline in price of oil by regulating its members' production levels. With the sharp increase in demand for oil in the past five years OPEC has occasionally found itself in a situation where it has had to ask its members to increase output in order to prevent the price from rising too fast. In 1999 OPEC committed itself to preserving the price of oil within a range of $22-$28 per barrel. On several occasions after 1999 OPEC increased production when the price rose above $28 dollars. Initially, OPEC was able to keep the price of oil within or near this range. In the past two years however, with the rapid increase in global demand for oil, the cartel has been unable to prevent the sharp increase in oil prices that we are witnessing today, because OPEC members are already producing up to their production capacities.   


This shortage of excess capacity, however, is temporary and the high price of oil has resulted in a surge of investment in oil and gas production activity, both inside and outside of OPEC. Indeed, the investment activities in the energy sector have increased so rapidly that there is now a severe shortage of material and technical experts in the oil industry. These new investments will significantly increase the supply of oil in the next few years. Saudi Arabia announced recently that it plans to spend more than $50 billion in the next five years to expand its oil production capacity.


As OPEC's production capacity expands over the next few years, its ability to influence the price of oil in either direction will increase. OPEC's influence in the oil market will also increase because its share of global production is expected to rise during the next decade.  


While currently the world demand for oil is so strong that producers can hardly keep up, the situation is likely to stabilize and on occasions lead to overproduction. This reversal can happen as early as mid-2006 and OPEC must decide on whether it should allow the price of oil to decline or to stabilize the price at current levels. In this article I argue that stabilizing the price at $40 to $60 per barrel will be better for the global community than a retreat to lower prices. OPEC (specially its leading producer Saudi Arabia) should prevent the price of oil from falling below this range.


Why higher oil prices are better?


They are better because they can encourage a more efficient pattern of oil consumption in the United States, which is by far the largest oil consumer in the world and is a major producer of greenhouse gases. The low price of oil in 1990s encouraged a wasteful consumption behavior in the U.S. that included a growing demand for larger passenger vehicles such as SUVs, which offer very low fuel efficiency. This consumption pattern was encouraged by the major car producers who saw more profit potential in sales of these inefficient cars. At the same time the politicians and U.S. government agencies turned a blind eye to this popular but wasteful trend and the average efficiency of passenger vehicles in use declines. Overtime the monster cars grew larger in size and number. By early 2000 SUVs and other monster cars had become a natural part of the suburban landscape in the United States. According to the National Automobile Dealers Association light trucks (including SUVs and Mini-Vans) accounted for 19.9% of new car sales in 1980. This figure rose to 54.3% of new car sales in 2003. It should be kept in mind that an SUV emits 100 tons of CO2 over its lifetime while the comparable figure for an average passenger car is 52 tons. (Source: Union of Concerned Citizens) 


In addition to causing air pollution, the excessive consumption of fossil fuels is a major contributor to global warming which is threatening our entire planet's ecosystem. Scientific research has clearly established a link between emission of fossil fuel gases and global warming. The world community is well aware of the adverse consequences of global warming and most industrial countries have signed the Kyoto treaty, which requires a reduction in emission of greenhouse gases.


Unfortunately the United States, which is the largest producer of such gasses, has refused to sign this treaty, despite the fact that majority of Americans are aware of the threat of global warming. The Bush administration has rejected the Kyoto treaty, because of the economic cost of limiting the emission of greenhouse gases.  


If the U.S. government does not have the political will to address the global warming threat by demanding a more efficient pattern of fossil fuel consumption from its citizens, then the only alternative is a higher price of oil and its derivatives. As the price of fossil fuels rises, the consumers and producers all over the world (and particularly in the United States) will switch to more efficient technologies. If the U.S. government and the auto producers are unwilling to curb the production of fuel wasting large cars, the high price of fuel will automatically reduce the consumers' demand for such vehicles and thus less will be produced.


Indeed the high price of oil in the past two years has already led to a reduction of demand for low-gas mileage vehicles in the United States. There is now a clear preference for fuel-efficient cars such as hybrids and the auto producers are responding. Car Market analysts predict that market share of environmentally friendly engines will rise from 4.8% in 2005 to 11% in 2010. Another positive statistic is the 81% increase in the number of hybrid cars registered in the U.S. in 2004, compared to 2003.  


Furthermore it is not just the American consumers that are responding to higher energy prices. We are witnessing some positive developments at the state government level. So far 19 States have passed laws requiring that a portion of their electricity come from renewable sources of energy. By 2009 at least 4% of Massachusetts's power must be generated by solar, wind or farm waste power generators. Minnesota has approved a law requiring utilities to generate at least 10% of their energy from wind power. State of Maine currently demands that at least 30% of energy be generated by natural gas or renewable sources (Wall Street Journal, June 8, 2005, page A4). If it weren't for the high price of oil none of these steps would have been taken.


What About OPEC's Self-Interest


If crude oil prices remain at the average levels of past 18 months production capacity outside OPEC will increase and OPEC will face more competition from other suppliers in the future. Would it not then be in OPEC's interest to lower the price of oil to discourage production capacity expansion in non-OPEC producers? The Answer is no. The competition that OPEC faces from non-OPEC producers will only be a threat to OPEC in the short-run. This threat will be limited in the long run because the global oil reserves outside OPEC are smaller than OPEC's and they are diminishing at a faster rate. Year after year OPEC's share of remaining world oil reserves will increase.


High production levels will put downward pressure on price of oil in the short-run and OPEC will have to cut back its output to preserve the price but its revenues will not necessarily be smaller than the alternative scenario of low price and high production level. The advantage of high price and smaller exports is that the oil reserves of OPEC members will be depleted at a slower rate. Furthermore, most OPEC members have accumulated large international reserves in the past two years. They can rely on these resources to sustain their fiscal spending during periods of low oil revenues that arise because of production cut backs. It is in OPEC's long term self interest to prevent any significant decline in price of oil, although it might lose market share in the short-run.


But Low-income Oil Importing Countries Will Suffer


This is true but OPEC can help relieve this burden on low income countries by increasing its imports from these countries and also by providing aid and foreign investment. The faster economic growth of OPEC members will also create additional job opportunities for expatriate workers from low-income countries. The number of expatriate workers in the Arab oil exporting countries of Persian Gulf has noticeably increased in the past two years as a result of increased construction activity. Those oil exporting countries that have achieved a high degree of prosperity have a moral obligation to provide more economic assistance to low income countries. In May 2005 the government of Qatar (the country with the highest per capita income in OPEC cartel,) announced that it will adhere to the United Nations recommendation of devoting 1.5% of its GDP to development aid for poor countries. It would be good for the international image of OPEC if other members also increased their economic assistance to poor countries.  


Global Warming is real and the damage that it can cause to the environment is already visible. We all have a responsibility to help reduce the emission of gasses that are contributing to this phenomenon. If some oil consuming countries don't have the political will to use oil more efficiently then the burden falls on oil producers to force a more efficient consumption pattern on these fuel wasting countries by keeping the price high. As the oil revenues of oil exporting countries increase, they also have a moral duty to assist the low-income countries.


About the author:

Nader Habibi is a regional economist for Middle East in the economic consulting firm Global Insight.


... Payvand News - 7/11/05 ... --

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