Economic Scarcity: Forget Geology, Beware Monopoly

Article excerpt

David L. Greene is a Senior Research Staff Member at the Oak Ridge National Laboratory.

Scarcity of oil poses a genuine threat to US energy security. At the same time, the world economy is in no danger of "running out of oil" during the next century. This apparent paradox has important implications for US energy security. The scarcity threatening US energy security today is an economic, rather than a physical or geologic, scarcity. Economic scarcity does depend on geology, but it can also be created by anticompetitive (monopolistic) behavior or may temporarily result from any of a variety of shocks to the world's oil producing regions. The inability of oil markets to adjust rapidly to sudden changes in supply enables supply shocks, whether deliberate or inadvertent, to produce enormous increases in oil prices and, consequently, immense profits for oil producers together with massive losses for oil consumers. It is the economy's susceptibility to sudden, massive economic losses that makes oil a serious energy security problem for the United States.

Over the past 25 years, the Organization of Petroleum Exporting Countries (OPEC) cartel has used its market power to create or capitalize on oil market disruptions. In October of 1973, the Arab members of OPEC announced an oil boycott against countries that aided Israel during the October War. From September to December, 1973, they reduced their crude oil production by 4.2 million barrels per day (mmbd), about seven percent of world oil supply in 1972. World oil prices doubled. Again in 1979-80, the loss of 5.4 mmbd of production from warring Iran and Iraq, about eight percent of world supply, produced another doubling in the price of oil. Following both shocks, OPEC members restrained their oil output, with the express intent of maintaining the new, higher price of oil. From May to December, 1990, total oil output from Kuwait and Iraq fell by 4.8 mmbd, about 7.6 percent of world production. From the second to the fourth quarter of 1990, oil prices jumped from US$18.50 to US$34.50 per barrel (measured in 1995 dollars). In contrast to previous price shocks, this one was short-lived as OPEC members, especially Saudi Arabia, responded by increasing output by more than three mmbd to replace most of the shortfall.

The oil market machinations of the 1970s and 1980s were very costly to oil consumers and very profitable for oil producers. According to the US Department of Energy, the price shocks and subsequently higher price levels of the 1970s and 1980s cost the US economy trillions of dollars. Between 1972 to 1991, these costs were approximately US$4 trillion dollars--equal to 80 percent of the United States' total expenditures on national defense over the same period. At the same time, many OPEC states were transformed from developing economies to among the richest nations on earth. In 1972, OPEC revenues amounted to US$24 billion per annum, but after the 1979-80 oil price shock, OPEC collected US$287 billion from oil consumers. Today, after ten years of cheaper and plentiful oil supplies, many believe such oil problems to be a thing of the past. This belief, however, is mistaken and dangerous.

After the first oil crisis in 1973-74, many believed that physical oil resources had suddenly become permanently scarce and that oil prices would inexorably continue to rise in the future. This view turned out to be wrong. High oil prices, sustained by OPEC's continuing efforts to restrain production, depressed oil demand and stimulated supply from non-OPEC producers. World oil demand, which had been growing at nearly eight percent per annum since 1960 until just before the 1973-74 price shock, slowed to an average annual rate of 0.4 percent per annum from 1973 to 1985. OPEC oil production, which had been increasing at an annual rate in excess of ten percent since 1960, actually fell at a rate of five percent per year from 1973 to 1985. Oil production by non-OPEC countries, which had been increasing at 5. …