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Commentary

A New Oil Crisis? Not So Fast


     
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US Congressman Jim Saxton, ranking Republican member of the Joint Economic Committee (JEC), released on last Thursday a study, “The Strait of Hormuz and the Threat of an Oil Shock”, that analyzed Persian Gulf oil shipments, scenarios of oil-supply disruptions, potential market reactions, and their effects on the price of oil and the impact on the US economy.

Contrary to the usual dire warnings one usually sees about threats to Persian Gulf and other regional oil supplies, which have been regularly issued since the Organization of Petroleum Exporting Countries (OPEC) oil embargo of 1973 and subsequently the Russian invasion of Afghanistan in 1979, the study concluded that the increased flexibility and resiliency of the US economy have improved its ability to withstand a temporary oil-supply disruption.

The study, written by senior economist Thomas W Boll, concluded with a prediction one rarely sees in a government publication, that the specter of a takeover of oilfields by some aggressor state is extremely unlikely.

Two additional observations are important. First, the likelihood is not great that Persian Gulf oil will be denied to the world. The incentives of most of the parties in the region will lead them to continue to produce and sell oil. OPEC abruptly shifted the terms of the oil trade in its favor once and cannot do it again; it can only improve the terms incrementally as the demand for its oil increases.

The parties from whom threats to the oil supply emanate are either disfranchised extremists with no regard for the costs they might impose on their compatriots or those who are engaging in brinkmanship. The former presumably lack the power to constrain the region’s oil supply permanently. The latter can use to their advantage only the threat of cutting off the oil trade and not the action, for the repercussions would be most severe for all of the Persian Gulf. The collective oil revenue of Gulf countries exceeded US$400 billion last year.

Second, the US economy and the world economy have become far more flexible and adaptive. Economic liberalization throughout the world has helped to keep inflation, interest rates, and labor costs low and laid a foundation for growth, despite the doubling of oil prices in recent years.

Public-policy responses to an oil-supply disruption are likely to be flexible as a result and avoid the use of price controls. This is not to say that an abrupt reduction in the oil supply could not cause a recession or derail economic advancement in the developing world, but the chances of overcoming a disruption have improved, provided it does not usher in an era of deteriorating oil supply.

Surprisingly, considering the Washington party line that Iran represents a threat to the Gulf region, the press release put out by Sexton noted, “Despite periodic threats by Iranian officials to cut off Gulf oil shipments, the credibility of these threats is questionable. The Iranian economy would be devastated by such oil-supply disruptions because of its own high and growing reliance on imported gasoline.”

The study makes a point that even those who flunked Economics 101 can understand that economic interdependency discourages embargos, boycotts and other interference with trade. The Middle East is no exception.

Even other, more traditionally pessimistic assessments confirm the JEC study. A draft of a July 18 study “Facing the Hard Truths about Energy: A Comprehensive View to 2030 of Global Oil and Natural Gas” done by the National Petroleum Council noted:

While overt war between countries of the Persian Gulf is unlikely, threats to and harassment of production facilities, refineries, terminals, and shipping remain a possibility. Extreme “resistance” groups seek to overturn the current order by means ranging from political activism to subversion and terrorism. Militants aim to remove many of the existing governments in the region and to drive Western powers and oil interests from the Middle East. While the likelihood of extremist groups actually taking over governments in the region is remote, there is a much greater possibility that non-governmental or para-governmental organizations could either disrupt supplies through the Strait of Hormuz or conduct a successful attack on a land-based facility.

While the JEC study is notable by virtue of being a government study expressing doubt about the threat to Persian Gulf oil by an aggressor state, which is code for Iran, it is hardly the first to do so.

A study “Energy Alarmism: The Myths That Make Americans Worry about Oil” released in April by the libertarian Cato Institute in Washington, DC, found that “concerns about political disruptions are exaggerated. Furthermore, maintaining US military forces in the Persian Gulf to reduce political instability, a common proposal from analysts concerned with ‘energy security’, is unnecessary and would actually increase the danger of political disruption to oil markets.”

The study noted that in the five major oil-supply shocks caused by political disruptions in the past 30 years—the Iranian oil-industry strikes in 1978, the collapse of the Iranian oil industry in 1979, the start of the Iran-Iraq War, the 1990 Iraqi invasion of Kuwait, and the 2002-03 strikes in the Venezuelan oilfields—market dynamics quickly mitigated the costs borne by consumers.

Even if one believes that al-Qaeda would like to disrupt oil-tanker traffic, as the White House claimed in the “10 Foiled al-Qaeda Plots” document it released in October 2005, the result would not be very significant. The JEC study found, “The key aspects of a disruption of tanker traffic in the Strait of Hormuz, therefore, are whether it would reshape future supply from the Persian Gulf and how the market assesses this possibility.

“The immediate loss of oil from the disruption would be secondary. Due to the experience of six oil crises since World War II, most oil-importing nations have accumulated substantial oil stores already. While a blockage of the strait would have a much larger impact on the daily flow of oil than any prior interruption in supply, oil released from private and strategic inventories, in theory, could manage the physical loss of oil for many months.”

What impact the JEC study will have remains to be seen. Chris Preble, director of Foreign Policy Studies at Cato, said by phone, “I and others have long wondered why it is so hard to break that [oil threat] orthodoxy. I don’t have a good answer for that.”


David Isenberg is Research Fellow at the Independent Institute.






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