LETTING THE U.S. OIL MARKET WORK

The Bush administration is coming to grips with the finer points of crisis oil market behavior. In a recent television interview, the President acknowledged that the embargo of Iraq and Kuwait is damaging the U.S. economy. To some, the statement might seem like an assertion of the self-evident. But in relation to the administration's former public posture, it plumbs new depths.

Nov. 26, 1990

3 min read

Earlier, the administration mostly hunted for "physical shortage." Finding none, it seemed to conclude that all was economically well. The search was futile, the conclusion faulty. A free oil market won't tolerate physical shortage, at least not for long. When something disrupts supply, a free market raises price to cut demand and create new supply sources. It's an efficient process, but costs are obvious.

MARKET IS WORKING

By acknowledging the embargo's economic damage, Bush was saying that the market is working. For letting that happen, his administration deserves enduring credit from the petroleum industry and consumers. In some past crises, U.S. officials declared petroleum too important to be left to market pressures. Their interventions created shortage and undue hardship.

Although it has resisted those temptations, the Bush team sometimes seems not to fully understand the market it trusts so much. The President continues to blame "speculation" for elevated crude prices. That's as futile as hunting for physical shortage. Markets anticipate events. Current prices reflect collective judgments by oil traders and investors about future supply and demand.

Economic damage the President seems only now to have discovered has been in prospect since the world lost oil supply from Iraq and Kuwait. If the administration had accepted the market's anticipatory function from the beginning and read it accurately, it could have foreseen the pain. Then it might not have intensified the distress by accepting an expensive clean air bill and huge tax increase purporting to balance the federal budget.

But that's history. The administration now must carefully weigh all the forces at work in the oil market-even the anticipatory pressures it doesn't like-and avoid misreadings that can lead at best to public misunderstanding and at worst to errors of policy.

One such misreading appeared earlier this month at the American Petroleum Institute annual meeting in Chicago. W. Henson Moore, deputy secretary of Energy, told a press conference that the crude price would be the same now as it was before the Iraq-Kuwait embargo if based only on supply and demand. Maybe he was just simplifying for reporters.

Whatever the reason, his assessment ignores the surplus production capacity that damped prices before the embargo and no longer exists. It ignores the economic strains essential to the delicate balance. It ignores all the potential upsets to that balance-such as an extraordinarily cold winter and production capacity lost to war-that imply higher prices.

INGREDIENTS OF SURPLUS

Indeed, in the indeterminate term, ingredients are in place for the next surplus. Whenever Iraq and Kuwait resume trade, worldwide production capacity will again exceed demand. The market will begin to discount that potential when current perils subside; prices will fall.

Somewhere in the future, then, lie prospects for an economic lift. And for the present there's this added consolation: If the administration had not trusted the market, if it had repeated the errors of its predecessors, the economic pain becoming apparent now would only have been worse.