Editorial: A changing oil market

Oct. 15, 2001
Aren't oil prices supposed to leap when warfare erupts in or around the Middle East?

Aren't oil prices supposed to leap when warfare erupts in or around the Middle East?

Shouldn't the prices of crude oil and petroleum products have zoomed after Oct. 7, when the US and UK, in response to terrorism in the US, began aerial bombardment of military targets in Afghanistan?

Apparently not. Prices at midweek had barely budged. The main question in the market was whether the Organization of Petroleum Exporting Countries would lower production quotas to prevent a price slump.

Expressions of surprise over the absence of price drama showed that an obsolete view of the oil market endures in the US and elsewhere. It was that view that caused lines to form at service stations in some American cities after the Sept. 11 terrorist attacks and gasoline prices in those areas briefly to approach $5/gal.

The old view

In the old view, the oil market is rigid and controlled by exporters whose production decisions are motivated as much by international politics as by economic interest. The old view anchors itself in the legacy of targeted export embargoes im- posed for political reasons by Arab oil exporters in 1973.

The problem with the old view is its failure to account for changes in both the market and ex- porter motives since the Arab embargo. But a problem with noting those changes is the temptation to assume that conditions won't change again.

In 1973, oil trade occurred in relative secrecy, mostly under long-term contracts. Trading pat- terns didn't adjust easily to physical upsets. Any surprise interruption in supply created panic buying in a thin spot market. It happened in 1973 and again in 1978-79, when revolution cut production in Iran.

In the 1980s, crude and products became commodities. Computers and oil-related derivative contracts made the market transparent and flexible. At the same time, newly enriched oil ex- porters were investing oil wealth in the development of modern nations.

As it demonstrated in the Persian Gulf crisis of 1990-91, the modern market adapts quickly to supply upsets. And as OPEC members other than sanction-bound Iraq demonstrated throughout the 1990s, key exporters base production decisions more on economic interest than on international politics. They have national infrastructures to defend now that didn't exist in 1973.

The question of the moment is whether and how the formula changes now that terrorist mastermind Osama bin Laden has called for a Muslim holy war against the West. Because of touchy internal politics, especially in Saudi Arabia, clear answers to that question don't exist. But hints about motive appear in revenue trends.

Oil-export revenues for all of OPEC rose on the strength of price recovery last year to an estimated $225 billion. It was the second yearly gain since 1998's $105 billion (in dollars adjusted to 2000 values), the lowest OPEC revenue total since the Arab embargo. In March, the US Energy Infor- mation Administration forecast a 4% decline in OPEC oil revenues this year to $216 billion.

Much has changed since then. But the importance of oil revenue to OPEC member govern- ments has not. As long as political stability in oil-exporting countries correlates with economic conditions, OPEC members other than Iraq will continue to seek a balance between price and market share that contributes most durably to their national revenues. A slowdown in market growth complicates the challenge. But the pursuit keeps exporters in healthy if sometimes uncomfortable alignment with the need of consuming nations for the free flow of oil in trade.

Desperation

The oil-consuming world must hope that political stability in the key exporting countries does not disengage from concern about national economic health. It can happen only if Bin Laden persuades Muslims in great numbers to reject modern life, which they will do only to the extent they have lost hope in what modern life offers. That he attracts any support at all reflects Muslim desperation-some of it the product of deteriorating prosperity associated with a long slide in oil revenues-that leaders of Muslim governments need to address.

They must keep production decisions grounded in economics. They also should look hard at how they spend oil revenue and make their spending decisions. Either issue can yield the oil market's next big change.