| When I put a $55 barrel of oil on the table and look at it from all angles, there?s no way the current price can be justified. As a free-market disciple, I am compelled to accept the market?s verdict: $55 a barrel. But that doesn?t mean it?s going to last.
Today?s oil episode is demand-driven, quite unlike the supply shocks of 25 years ago. Back then, OPEC withheld oil because they disagreed with the U.S. policy-tilt towards Israel. Additionally, under Presidents Ford and Carter, U.S. energy policy generated strict price controls and supply allocations, a most bizarre policy combination that kept oil from those population centers most in need of it.
Oil is certainly flowing today, but at much higher prices. In fact, in real inflation-adjusted terms, today?s oil price is the highest since 1983. To a certain extent, we owe this to a favorable development: the global spread of market capitalism in emerging economies such as China, India, and Eastern Europe. At the margin, the increasing oil demands of these countries have undoubtedly boosted the barrel price.
It is instructive to note how much higher oil prices have jumped in comparison to other commodities. From the 2001 low, oil has increased 214 percent. Over the same period, an index of metals -- equally in demand from the emerging economies -- has risen 122 percent. Seemingly along for the ride, gold prices have increased 73 percent. Meanwhile, the S&P 500 stock index has rallied 55 percent from its late 2002 low point while the broader Wilshire 5000 has gained 62 percent.
The fact that oil has increased so much more than these commodity and financial-asset prices is important. It suggests that the oil sector is way out of line. Increased China demand cannot alone explain it -- over-speculation is also a culprit.
It is rumored that hedge funds have used low interest rates to leverage and borrow for the purchase of oil market contracts. Big oil companies may also be speculating on higher future oil prices, with or without leveraged borrowing. It may also be that tanker companies have slowed down their deliveries as they wait for still higher prices.
Fortunately, the U.S. economy is much less susceptible nowadays to the tax-hike impact of higher oil prices. Numerous studies have shown that greater efficiencies in oil and energy usage have lowered our vulnerability to energy shocks by roughly 50 percent in relation to 25 years ago. Rather than stagflating, today?s economy is quite healthy.
So, what to do?
Ultimately, the answer to high oil prices is a lot more production. That?s exactly what the Bush administration intends to do. New Energy Secretary Sam Bodman has been put in place to implement Bush policies for greater nuclear energy use, increased use of clean coal, the development of a free-trade national electricity grid, and the foreign coordination of liquid natural gas. Also in the policy mix is new oil and gas drilling in the Arctic National Wildlife Refuge (ANWR).
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