Beware of Oil Pundits

WASHINGTON—Complaints about the price of oil and the profits made by oil-producing dictators have a sudorific effect on me. The sweat turns into panic attacks if the complainers actually start to offer solutions.

Two of the brightest people around, Thomas Friedman and Steve Forbes, have just proposed major action. In his magazine, Forbes advocates preventing foreign despots from continuing to make a killing on oil by reducing the amount of money in the system—inflated liquidity that he estimates is an important cause of current oil prices. Friedman, for his part, writing in the journal Foreign Policy, posits the First Law of Petropolitics, arguing that high oil prices undermine basic liberties by empowering despots in oil-rich nations. In a separate piece for The New York Times, he had already recommended that the government discourage the use of gasoline by imposing high taxes, mandating that every car be flex-fuel capable, and subsidizing Detroit’s transformation of its current fleet.

Inflation is not driving oil prices. The main factor is a simple case of supply and demand. World demand has grown by 7 million barrels per day since 2000, with almost a third of it coming from China. At the same time, Iraq’s oil production is well below prewar levels. If you add the slowdown in the expansion of Russian production and a reduction in Venezuela’s output because of government incompetence, and the effect of last year’s hurricanes in the U.S., you will see why traders anticipate a mismatch between demand and supply. That does not mean there is no inflation around. But who can ascertain that a large chunk of the new money is being spent on oil? It is probably chasing many other things. Soaking liquidity to tackle oil prices and despots’ profits is like draining the Caribbean to get rid of all the sharks in the world.

Friedman is right that the windfall obtained by tyrants enhances their power at the expense of their people’s freedom. But many other things have that same effect and there are just as many examples of liberty expanding in times of high oil prices as there are examples of the opposite. The greatest wave of democratization in Latin America since World War II came at the beginning of the 1980s, coinciding with the high price of crude that followed the 1979 oil crisis (some Latin American countries are highly dependent on exports of crude). Hugo Chavez’s early consolidation of power—when he sidelined Congress and used a constituent assembly to change the rules—began in times of low oil prices. Mexico’s political freedoms have expanded, not diminished, during the recent oil boom.

Those who espouse clever government-led solutions to high oil prices should bear in mind that new discoveries have outpaced consumption for a number of years, but too much bureaucratic interference has hampered supply. Restrictions on building new refineries and pipelines in the U.S. have kept prices up and increased America’s dependence on foreign energy. Half of Europe’s motorists already use diesel fuel, but the lack of refining capacity to turn heavy crude into diesel has made the rest of the world rely a lot more on light crude, pushing up its price. And, of course, supply would be higher if almost 80 percent of oil reserves did not belong to incompetent government-owned companies around the world, such as in Russia, Sudan and Nigeria. Not to mention that huge tariffs on imports of Brazilian sugar cane have hampered the development of ethanol in the U.S. (Brazil’s use of ethanol as an energy source has been a huge success.) Why make matters worse by meddling further?

Consumers and entrepreneurs are better at sorting out oil crises than pundits and governments. They know that tyrants cannot afford to manipulate prices too much because they will lose their revenue by encouraging diversification and alternative energy. Consumers used less gas after the oil crises of the 1970s and businesses started developing oil extraction in the North Sea and Canada. At current prices, you can be sure that fresh capital is going into oil and the corresponding increase in supply will eventually moderate prices—not to mention the fact that new capital will also tend to go to alternative energy sources. In any case, the world economy has been growing at a pretty healthy rate even with oil at over $60 a barrel.

Because oil is finite, it will eventually be replaced. Let that happen in its own time, without forcing measures with huge side effects that don’t solve any problems. Every energy era has its good and its bad side. In the 19th century, kerosene lamps replaced whale-oil lamps. Whales were probably saved from extinction.