When it comes to energy, the past year has demonstrated to the oil producers that $10 oil is too cheap and to the consumers that $35 oil is too expensive.
We all know that $10 oil was the result of increased quotas on the part of OPEC, which raised production above demand, and that $35 oil is the result of OPEC quotas that reduced production below demand. We also know that $10 is too cheap because of the havoc it created in the US oil patch; exploration and production dropped, and employment fell to record lows. With time, $35 oil will result in increased production with or without OPEC cooperation. The danger, of course, is that with increased production we will again enter a period of low oil prices and be back to where we began.
Neither producers nor consumers benefit from the kind of volatility in oil prices that we have recently witnessed. Low oil prices create economic and social unrest in the oil producing countries dependent on oil revenues, while high oil prices can and have led to recessions in the consumer countries.
Perhaps, with the effects of both high and low oil prices still fresh in our memory, we are ready to try an approach that would reduce the volatility in the price of oil. What is needed is an international association of the major oil consumer and producer countries, which would work to stabilize oil prices around an agreed-to level beneficial to both.
The association could work in the following way:
The members of the association would agree to a fair and reasonable price for oil-for example, $22.50/bbl-and agree to an acceptable lower and upper limit to that price, say $20 and $25/bbl. Every 3 months the association would estimate world oil demand for the next 3 months and apportion oil production among the producer countries to meet that level of demand.
The producer countries would agree not to produce in excess of their quota and the consumers would agree not to purchase more oil from a given producer than its assigned quota. The association members would contribute to the maintenance of a buffer stock and a cash reserve. If the price of oil rose above the earlier agreed-to upper limit, the association would sell oil from its buffer stock to bring the price down. If the price of oil fell below the lower limit, it would purchase oil in the market until the price returned to the agreed-to level.
In cases where the association bought oil, it would reduce the quota for the next quarter by an amount sufficient to sell that oil back into the market. Similarly, if the association sold oil from its buffer stocks, it would set the next quarter's production quota at the amount needed to meet projected demand and to replenish its stocks. As added insurance that quotas will be honored, the shipping companies would need to agree not to transport more oil from a given producer country than its assigned quota.
Clearly, for such a system to work, a level of cooperation and commercial transparency greater than has existed in the past will be needed. Certainly the internet technology exists to make the needed information instantly available. The only question is, have the producers and the consumers suffered enough over the past year that they are ready to stabilize oil prices at a level beneficial to all?
Raymond R. Knowles
New York
