Editorial: Perils of policy

March 21, 2005
Yes, relentlessly increasing demand for oil is straining capacities of global supply systems, from production to refining to shipping.

Yes, relentlessly increasing demand for oil is straining capacities of global supply systems, from production to refining to shipping. And, yes, governments should react to the inevitable pressures on price. But any reactions by governments must aim at fortifying, not replacing, market responses. In most cases, that means getting out of the way.

The International Energy Agency implied something different in the March edition of its closely watched Oil Market Report.

“The reality is that oil consumption has caught up with installed crude and refining capacity,” IEA noted. “Refiners are already competing to secure crude for the second quarter to rebuild depleted distillate stocks and to meet summer driving season and air conditioning demand. Capacity limitations are once more being tested by strong demand growth, keeping prices high.”

"Policy attention"

These are all characteristically keen observations about the oil market. But IEA goes on: “If supply continues to struggle to keep up, more policy attention may come to be directed at oil demand intensity in our economies and alternatives.” Here’s how the usually more restrained Financial Times interpreted IEA’s suggestion, in a front-page headline of the Mar. 12-13 edition: “Call for world to turn away from oil.”

IEA might not have been calling for exactly that when it muttered about policy attention to demand and alternatives to oil. But any indulgence of market manipulation by governments invites mischief.

Why even hint about such a mistake now? Capacity strains have been evident for a couple of years. In fact, they were developing in the 1990s until the Asian financial collapse stalled demand growth. But Asian economies have revived, China has surged, and the industrial economies have proven to be surprisingly resilient to rising prices of oil, gas, and most other commodities. Oil demand has expanded as a consequence, outpacing expectations and creating the pressures IEA cited on supply capacities.

There are reasons to worry. The ability of production of conventional crude oil to grow, especially outside key members of the Organization of Petroleum Exporting Countries, is reaching natural limits. And no single source of unconventional supply, whether heavy oil from Canada or Venezuela or liquids processed from large but undeveloped gas deposits, can meet projected needs as growth subsides in conventional supply. At present, therefore, it is possible to forecast strongly increased consumption levels by 2025-30 but impossible to say how the demand will be satisfied.

The uncertainty is no reason to hail government energy prescriptions. It is, in fact, a strong reason to shoo governments away from energy markets.

In the absence of a flurry of giant oil discoveries, which is unlikely, or a major technological breakthrough in nonfossil energy, which is even more unlikely, future energy supply will be a mosaic of shrinking pieces. It will depend on continuous additions of production from conventional and unconventional hydrocarbons and from energy sources now called “alternative.” The additions will be stimulated by elevated price, which will restrain demand growth-almost certainly enough to keep current consumption projections from coming entirely true.

This already is happening. As IEA noted in February, OPEC members able to do so are adding capacity to produce conventional oil. Heavy-oil projects are expanding and growing in number. Commercial-scale gas-to-liquids projects are planned and under way. Biodiesel and other alternative-energy projects are proliferating, some commercial, some promising, and some feeding off false hope and destined to vanish.

More initiatives

The sum of output rates from all these initiatives atop likely production from existing sources yields supply nowhere nearly sufficient to fill demand at forecast levels. So the world needs more such initiatives. In fact, the number of energy projects required by a world increasingly dependent on multiple increments of supply is very large. That should pose no problem. Under the right technical, economic, and political conditions, the necessary projects will emerge.

Governments properly react to energy challenges by optimizing the political conditions of energy investment, facilitating markets, and letting projects happen-even encouraging them. But they must resist their natural urges to control prices, dictate consumption levels, and make fuel choices. If they do, if markets remain free, the technical and economic conditions essential to investment in energy supply-oil, gas, and everything else-will take care of themselves.