The world now glowers at oil. Prices of crude oil and petroleum products have reached unprecedented levels. Heavily taxed European consumers are protesting in various ways. Newspaper headline-writers have rediscovered the phrase "oil crisis."
A complex subject largely absent from public debate since the Persian Gulf crisis of 1990-91 thus reenters the steamy realm of controversy. Celebrity analysts and public officials expound urgently on topics about which they thought little during most of the past decade. The oil industry therefore should prepare to defend itself against a revival of old myths such as these:
- There's no visible shortage, yet prices are rising; somebody must be cheating. Shortage is, by nature, invisible, except when governments or protesting truckers obstruct physical delivery. Otherwise, supply and demand always balance at some price level, the main question being which factor represents the main constraint. When supply is the main constraint, as it is at present, there is shortage, the only visible effects of which are low inventories and high prices. There can be no void labeled "shortage" able to ratify a price rise to the satisfaction of consumers.
- Oil consumption is inelastic to price because consumers pay whatever they must in order to acquire oil. History suggests otherwise. Each of the major oil-price leaps since the Arab embargo of 1973-74 has been followed by a sag in worldwide demand. The effect is often slow to appear in demand statistics and moderated by other factors, such as consumer wealth. But it's real.
- Product prices always rise faster after a jump in the price of crude oil than they fall once the crude price subsides. Sometimes, maybe, but definitely not always. Product-price declines occasioned by retail competition often precede crude-price weakness, in fact. But no one outside the industry notices when that happens.
- With prices, crude is always the cause, products the effect. Wrong. As noted above, the market works in both directions. At present, factors downstream of the wellhead, especially transportation and processing capacities, have more to do with high product values than the amount of raw material entering the system, important as that is.
- Oil companies set the price of oil. False. If they could, they would have set oil prices far above levels of, say, 1998, which was financially disastrous for them. If companies could set the price of oil, their net income from US production would have been far greater than the 7.5% of net investment average of 1990-97. Oil companies influence the price of oil mainly through decisions about investment in and utilization of capacities to produce and refine crude oil. That influence is itself a function of price, which just as greatly reflects consumers' decisions about buying oil.
- Members of the Organization of Petroleum Exporting Countries set the price of oil. If they could, they would have set oil prices much higher than levels of, say, 1998, when their total oil revenues, adjusted for inflation, were lower than at any time since before the Arab embargo of 1973-74. OPEC members influence price mainly through production decisions, which affect the supply of crude oil immediately available to the market. The degree of that influence varies and is constrained by investment decisions of nonmembers and purchase decisions by consumers.
- Consumers have no influence over the price of oil. Wrong. As noted above, they influence the price with their decisions about whether and where to buy petroleum products.
- Oil is too important to leave to the market, so governments should set the price. Hardship involving oil is always greatest where governments are most involved in the pricing and allocation of oil. In fact, oil is too important not to leave to the market, which is demonstrably the most efficient mechanism for arbitrating supply, demand, and price.
There's one other myth onto which the oil prices of the moment cast useful perspective. It is that consumer interests should be sacrificed to environmentalist judgments about petroleum, all of which are negative and argue for levitating retail costs with tax increases so as to discourage consumption. In fact, consumer interests matter-now and always. Those protesting truck drivers in Britain and fishermen in France seem clearly to have taken the point.
