Monday, June 26, 2006

Oil Addiction

A week ago USA Today published an editorial titled “Oil Addiction”. The author laments that oil addiction makes US government too soft of dictatorial and tyrannical regimes. Of course, Russia is included as an example of an oil rich dictatorship. In truly Puritanical tradition the author appeals to the superiority of moral values over materialistic needs such as consuming energy. I doubt that if America refuses to buy oil from dictators, such as Saudi Arabia, Venezuela, Iran, etc. its citizens rejoice and stop driving SUVs, using air-conditioning and start paying triple utility bills. The author writes:

Much of the problem is driven by the USA, which accounts for a quarter of the world's oil consumption. There are no easy solutions. Increased gas taxes are a tough sell. Domestic drilling is inadequate to the task. And practical alternatives to oil might or might not materialize. But as unappealing as these may be, ignoring troubling world developments is worse.

One place to start is to recognize that the central question is not what we should pay for energy but how we should pay for it. If we can begin to shift the hidden costs away from the taxpayers and onto energy consumers, the true nature of our addiction will be more visible.

Somehow US Today editors and many other dictatorships’ watchers forget about the other side of the problem with high oil prices. Very high oil prices – or better said constantly increasing oil prices – are beneficial for contemporary American economic policies. Oil trade in the world is done in American dollars – green pieces of paper printed in the US. Since March 2006 the world doesn’t even know how much green paper America currently prints. But as long as increased amount of green paper is happily consumed by international oil traders due to increasing oil prices, everything is ok. America can afford its tremendous budget deficit not fearing inflation.

There’s a traditional scary story for Russia – your economy will collapse when oil prices go down. Probably it’s true. But low oil prices will also make a lot of American green paper useless – it will flood back to its native land. Is America ready to live with huge budget proficit? Is it ready to live with double digit inflation? Ironically the financial crisis could also solve the problem of oil addiction – unemployed don’t drive SUVs even if gas is very cheap.

17 comments:

Anonymous said...

• Russian economy would be nonexistent w/o the oil industry (do, lookup what % of Russian GDP the oil industry makes up – that should clear up any misconceptions).
• Nobody is talking about crude going below $50/barrel any time soon anyway.
• The fact that oil is traded in $ is NOT determined by the US, there’s simply no viable alternative (otherwise, given the current level of popularity of the US in the world, it’s safe to say that the dollar would be substituted for anything even remotely suitable.)
• What else have you got?

Dmitry.

Sean Guillory said...

I agree with Konstantin.

There has been increasing talk to use Euros in the oil market. The Iranians have been threatening the idea for a few years now. Many believe that if a euro market would succeed it would drive down the value of the dollar because some banks would begin transfering their reserve currency to euros. The question is if a euro market would succeed.

American oil addiction is a win in the short term but a loss in the long. High oil prices will bring big profits, but the increasing cost of fuel will enevitably suck more and more consumer income away. I saw a news report on CNN a few weeks ago about how a family in Iowa was spending $730 a month on gas. I pay more in rent. This can't last long.

It also doesn't bode well for Russia since its current boom is driven by oil and gas. But I seriously doubt oil prices are going to go down. If anything they are going to go up as global consumption continues to outstrip production.

twicker said...

Sean and Konstantin:

1) The price of oil doesn't determine money supply (which is what could flood anything with dollars). See this Wikipedia article for a good explanation of money supply. If you want to try to calculate the effect of oil prices on the money supply, you might want to check out the Fed's M1/M2/M3 historical data.

2) Oil isn't traded in dollars; it's priced in dollars. *Americans* pay dollars for oil, and people who have dollars in reserve might pay dollars for oil; however, Europeans tend to use Euros to buy -- though they do it at whatever the exchange rate is for Euros-to-dollars. When the Brits pump Brent crude, and sell it to Brits, they don't keep transferring money from pounds-to-dollars-to-pounds-to-dollars-to-etc. to get it from the Brent Sea to a lorry in London. You don't buy petrol for your Peugeot in Paris using dollars; you use Euros, just like the gas station did when it bought the petrol from the supplier, who bought it from ... etc. When I drove by petrol stations in Krasnodar, the prices at Lukoil were in the same currency that was used to purchase the oil all the way up to the crude that was pumped out of the ground in Siberia -- RUR, not US$. Pricing oil in dollars has zilch to do with what's going to happen to the US economy.

3) High oil prices don't help the US economy, and falling oil prices don't hurt it. Check out any of the stats on the economic history of the US if you have a feeling you might disagree.

4) In fact, high oil prices specifically *hurt* the US economy, and falling oil prices specifically *help* it -- precisely because the US is an oil importer. The more we have to spend on oil, the more of our wages go to places other than our immediate neighbors -- meaning money is moving out of the US. The higher the price, the faster the movement. Assuming people aren't then suddenly wanting lots *more* American imports (they haven't yet), that money doesn't come back -- it goes to help the economies of other states. Which is great for those other states, but not so great for the US. There's no short-term benefit at all, unless you want to consider the increases in efficiency to be short-term benefits.

5) While the focus on Russia is a bit of a stretch in the article, the article isn't advocating lower oil prices -- it's advocating higher efficiency. It's well known that the best way to expand an economy without increasing inflation is to increase efficiency. Given the growth that America has, a fairly dramatic increase in efficiency won't leave almost anyone jobless (except makers of SUVs, possibly) and won't hurt the economy one iota -- in fact, it will make the economy more resilient, and less prone to energy price shocks. It's about the most win-win situation imaginable.

Trust me: the Great Collapse of 1998 didn't happen because the various countries had too much energy efficiency. And the American economy didn't pretty much sail through 1998-1999 without effect because energy costs went up; in fact, energy costs went down, and America had one of its largest peacetime expansions in history (yes, primarily due to "irrational exuberance," but it's an expansion nonetheless -- meaning that low energy prices do not, ipso facto, produce some sort of US economic crisis).

Efficiency is almost universally good, and will not, under any circumstances, produce a US economic collapse. And, anyway, as Sean points out, it's not like global demand is going to slack off any time soon: China and India are both still expanding rapidly, as are Brazil and Russia. If the US hardens itself to shocks, and thus keeps oil prices at their current level, allowing developing countries to ramp up without going under, that's not a bad thing, IMHO.

I take it that the projected US economic crash is some wishful thinking on your part, Konstantin? Unfortunate, that -- for my part, I don't wish ill for your country. I have too many Russian friends to hope that the country they're proud of suffers another collapse.

-- twicker

Konstantin said...

2 twicker

Yes, I agree. The problem is much more complex as is the problem with all complex open systems - economical systems including. Hundreds of factors are intervened but I still believe that among these many factors is the beneficial (for the US) possibility to supply growing demand in the world for dollars. Because oil is not only priced in dollars but is also traded in dollars between countries with "soft" currencies. And most of oil trading countries have "soft" high risk currencies. We don't take Chinese yuans for Russian oil. And around the world oil trade is the major inter-state trade product. We give China dollars for clothes - China gives us dollars for oil. US prints these dollars. Inflation in America stays low.

Again, I mostly agree with you. My remark was just one point in the bigger picture.

The Ranger said...

Twicker, Well said , very well said. Thank you

Anonymous said...

The price for a barrel of crude oil should be in euros, not in dollars.
That should ease things down in the financial markets.
The EU already seems to do so at: http://www.energy.eu/#prices

mhelvin said...

I definitely agree with Twicker, you should run as the speaker of the house heheh... no joke .. very well said..

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william said...

If we're addicted to oil, our twelve-step program should begin with admitting that we have a problem. As the price of oil creeps ever higher, finding new energy sources is more important than ever. But the search for alternatives, combined with environmental disruptions, is putting new pressures on other essentials like food.
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