March 30, 2004, 8:00 a.m.
OPEC Is the Problem
Want gas prices to drop by half? Remove the oil cartel.

By Jerry Taylor

Is the OPEC cartel a good thing for consumers? Its raison d'etre, after all, is to radically restrain production in order to jack up oil prices. Given the political and economic angst sparked by the recent spike in gasoline prices, you'd think the answer to this question would be rather obvious.

But to Washington politicos and policy mavens it's not. In fact, many today who are content to leave the cartel alone are even defending OPEC against those who want to tear it down. These OPEC apologists contend that the cartel assists in stabilizing oil prices. The record, however, suggests otherwise.

In the period between World War II and the formation of OPEC, the inflation-adjusted price of oil fluctuated little. Oil prices indeed jumped during the Middle East crises of 1956 and 1967, but they fell back quickly. The inflation-adjusted price of oil — indexed by gross domestic product — fell by about two-thirds from 1945 to 1970.

From 1970 to 1980, however, the real price of oil rose by about 1,300 percent. Between 1980 and 1986, it dropped by about two-thirds. It was fairly steady between 1986 and 1997, fell farther between 1997 and 1998, and then nearly quadrupled after February 1999. This is stability?

Cartel prices fluctuate more because they are less certain than normal market prices, inviting speculation. In short, market agents are forced not only to consider global supply and demand but also to factor in OPEC's behavior and its members' fidelity to their promises. Hence, the market is less predictable and prices are accordingly more volatile.

The price spike in late 1973 is instructive. Although there were only trivial changes in world oil supply, prices rocketed — a phenomenon that can only be explained by buyers' panic.

Others believe that OPEC is doing us a favor by producing oil in dribs and drabs because underproduction now postpones the end of the oil age. The widely advertised, long-predicted end of the oil age, however, is like the horizon — forever receding as we move closer to it.

How would we know if oil was indeed becoming scarcer? The only certain metric would be “finding” costs. If oil stocks were indeed dwindling, it would be more expensive to find and develop each additional barrel of oil. Up until about 15 years ago, however, finding and developing costs were trending downwards, not upwards.

Since then, most of the data on the matter have simply disappeared. As an alternative, economists Morry Adelman and Campbell Watkins tabulated the sales value of proved reserves in the United States, information that serves as a window on the value of oil reserves anywhere in which oil finders can go freely and invest. From 1982 to 2002, however, the price of existing reserves did not increase, demonstrating that the market does not believe oil in the ground is an appreciating asset.

Someday, of course, oil stocks will indeed begin to dwindle. When that might be, however, is unknowable because new technologies continue to emerge that make finding and producing oil cheaper than ever before.

Regardless, we don't need OPEC to manage the future. When depletion becomes a real problem, oil prices will rise of their own accord and economies will adjust because prices today reflect expectations about prices tomorrow.

OPEC's defenders also contend that high oil prices bring political stability to the Middle East and that low oil prices bring political instability. Perhaps. But why is a stable Saudi, Iranian, or Libyan regime in our interest? While we could perhaps imagine worse regimes, we could certainly imagine better. But more to the point, the argument that these undemocratic, oppressive, ideologically bizarre, and terrorist-friendly regimes are propped-up by high oil prices is scarcely a strong argument for applauding the cartel's machinations. In fact, President Bush's program to encourage human rights, democracy, and peace in the Middle East will not succeed as long as these regimes remain in power in their current incarnations.

Let's be clear about what's at stake. If OPEC disappeared tomorrow, oil prices would drop to somewhere around $8 a barrel and gasoline prices would almost certainly be south of $1 a gallon. A price collapse of that magnitude would do more for consumer welfare and the overall health of the American economy than almost anything that's been put on the table by President Bush or his Democratic party rivals. Accordingly, the OPEC cartel should be resisted, not embraced, and policy should aim at undermining it, not propping it up.

— Jerry Taylor is director of natural resource studies at the Cato Institute.

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