ANSWERING OIL PRICE DEMAGOGY

The oil consuming world embargoes 3-4 million b/d of crude oil from Iraq and Kuwait, and Congress demands to know why U.S. gasoline prices jumped so soon. Amazing. The question of the overheated moment is whether lawmakers want the answer this time. Probably not. Lawmakers probably just want a political punching bag to dissipate heat from the savings and loan scandal. So oil companies have two choices. They can cover up and hope the name calling subsides without generating punitive
Aug. 13, 1990
3 min read

The oil consuming world embargoes 3-4 million b/d of crude oil from Iraq and Kuwait, and Congress demands to know why U.S. gasoline prices jumped so soon. Amazing. The question of the overheated moment is whether lawmakers want the answer this time.

Probably not. Lawmakers probably just want a political punching bag to dissipate heat from the savings and loan scandal. So oil companies have two choices. They can cover up and hope the name calling subsides without generating punitive legislation. Or they can come out fighting.

Calling for the aggressive approach is easy. Implementing it is another matter. How does an industry explain the oil market's fits and starts to an audience historically disinclined to learn? First it needs to attract credulous attention. Voluntary wholesale price restraint announced by several companies last week was, therefore, an excellent start.

COVERING UP RISKY

Moreover, covering up involves risks. If crude prices remain high more than a few days, and if product prices stay anywhere near in step, oil company profits will rise in the third quarter. The reports will come in October, with political campaigns at full frenzy. Even if gasoline price hysteria abates now, it may well revive when companies publish third quarter results.

So why not come out fighting? Why not tell it like it is?

Current supply and demand numbers do not explain the sudden gasoline price jumps. Oil markets remain in surplus-for now. But markets react immediately to news, especially news of events that might turn surplus into shortage. Wholesalers and retailers must replace what they sell. Shortage threats encourage hoarding.

The Arab embargo of 1973-74 made the oil market hypersensitive to shortage. Fear of shortage, multiplied by every buyer and seller of oil everywhere in the world, can and does push up prices in the short term regardless of immediate supply and demand. Thus, when revolution cut production in Iran in 1978-79, shortage-minded traders bid up crude prices beyond levels warranted by the supply interruption's size.

Another Middle East disruption occurred Aug. 2, when Iraq invaded Kuwait. Ironically, Iraq could have made more money by keeping its and Kuwait's production on stream fetching $18-21/bbl than by fulfilling the market's greatest fear: shutting in Kuwaiti output to drive the crude price to the $24-25/bbl levels of Saddam Hussein's earlier rhetoric.

But that doesn't matter. Retaliation by the U.S. and others-military mobilization and economic embargo-removes 3-4 million b/d of crude from the market. Without compensating production increases elsewhere, inventories eventually will shrink, and shortage will follow. To expect markets not to react early to the prospect is naive.

ROOM FOR RESTRAINT

Oil companies didn't create the threat of shortage. An economic embargo-the proper response to brazen international aggression-did. Oil companies should point that out. Similarly, oil companies didn't intensify consumer fears. A few congressional demagogues did, prodded by media promises of a price spike after a fanciful late July production accord by the Organization of Petroleum Exporting Countries. Oil companies should point that out, too.

President Bush asks companies to "show restraint" in pricing during the crisis. Fair enough. Plaudits to the companies that quickly responded last week with price freezes. In the longer term, oil companies can't affect prices much in either direction in an atmosphere of engineered shortage, panic buying, and market fears inflamed by political bluster. This is a crisis. There's room for restraint on all sides.

Copyright 1990 Oil & Gas Journal. All Rights Reserved.

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