The Oil Follies? Our Fault

By Michael Kinsley

King Abdullah just summoned everybody to Saudi Arabia to sort out the whole oil business, and the first humiliation for the U.S. is that we came running. Then again, this is old news. For 35 years, since the first oil crisis, we've been treating OPEC, and especially the Saudis, like friendly members of the Society of Important Countries rather than the criminal conspiracy they are. The second humiliation is that the meeting didn't work. The small gratuity offered by the Saudis of a modest increase in pumping had virtually no effect on the price of oil, which remained above $130 per bbl. The third humiliation is that by going to this meeting and begging the Saudis to increase production, the U.S. revealed its complete ignorance of basic economics.

At this point, the Saudis would also like the price of oil to moderate. But that doesn't mean their interests and ours are now aligned. The way to squeeze as much money as possible out of the power to control the spigot is not to raise prices indefinitely. It is to figure out the point at which the extra money you get from the higher price is no longer more than the amount you give up in lost sales. Making this calculation regarding oil is especially tricky because of the differing calculations for the short run vs. the long run. In the short run, it's fairly easy to raise prices because there isn't a lot that people can do in response. They still have to drive to work, and Washington would still be unlivable without air-conditioning. In the longer run, people can buy smaller cars, insulate their houses and so on. Energy efficiency--the amount of energy required to produce a dollar of GDP--has actually doubled in the U.S. since the first energy crisis. And $4-per-gal. gasoline is clearly having a significant effect on energy use.

The Saudis apparently believe that a lower oil price will be good for them in the long run. If they're right, it surely means that a lower price would be bad for the U.S. When it comes to the price of oil, the interests of producers and consumers are diametrically opposed. Whatever pious rhetoric comes out of exercises like this absurd "summit," there is no way that a change in either direction can be good for everybody. It's a zero-sum game.

King Abdullah's seemingly generous offer of a billion dollars from OPEC countries (plus $500 million from his own treasury) to help poor countries cope is also nothing to be grateful for. It amounts to backdoor price discrimination: charging different customers different amounts to extract the maximum from each.

Back in the U.S., both parties' presidential candidates are humiliating themselves and us with economic nonsense about oil. John McCain speaks passionately on the need for energy independence, but he is sticking to his counterproductive notion of a gas-tax holiday that would cut less than 20-c- from the price of a gallon. This man really thinks we're chumps.

Barack Obama's great insight is to blame "speculators" for raising oil prices artificially. This could even be true, but if so, it's irrelevant. Speculators cannot affect the price of oil in the long run. What speculators do is get us to the long run sooner. If they think underlying forces of supply and demand will ultimately result in oil at $200 per bbl., they will bid up the price until it is close to $200 per bbl. already. Similarly, if speculators think the price of oil will go down, they will drive it down more quickly. So, actually, speculation can be seen as a good thing: it forces us to adjust to higher prices more quickly than otherwise, and it gives us the benefit of lower prices more quickly as well.

It's interesting to consider what the price of oil would be today if it had been higher in the past. Suppose, for example, that President George W. Bush had used the political gift certificate he was granted on Sept. 11, 2001, when he could have asked Americans to do almost anything in the name of fighting terrorism, to impose a $1.50 "War on Terror" tax on a gallon of gas (instead of squandering his gift certificate on invading Iraq). The price at the time was about $1.50 per gal., so this would have doubled it to $3. People would have screamed with pain, then started adjusting. Demand would have gone down, and today gas would probably be selling for less than the $4 per gal. we're paying. Not only that, but $1.50 of that price would be staying here in the U.S. instead of going to Saudi Arabia or Venezuela or Bahrain.

To the rest of the world, we look like idiots. In fact, regarding oil, we really are idiots.