Oil prices -- the marketplace is not enough

By , Robert R. Bowie has been concerned with foreign affairs for 35 years while serving on the Harvard faculty, in various government posts, and as a consultant. He is currently a guest scholar at the Brookings Institution.

An interdependent global economy poses some hard dilemmas for policymakers. Pursuing short-term advantages often puts in jeopardy longer-term needs. And the conflicts in immediate interests among various nations or groups may block cooperation necessary to advance shared long-term interests.

Oil and energy issues illustrate both problems. The oil-importing countries are delighted that OPEC has been forced by the current oil glut to cut its base price from $34 to $29. That is understandable. The price jumps in 1973-74 and 1979-80, which made oil 12 times more expensive, have been extremely costly for their economies. The $5 drop in price seems to signal a decline in OPEC control; indeed some foresee a further slide to still lower prices. Of course, for oil exporters like Mexico, Nigeria, Indonesia, and some smaller producers the reduced revenues will disrupt economic progress and complicate debt repayment with risks for some lending banks. But the oil exporters' loss appears as a gain for oil importers, at least in the short run. For them, the lower price should help reduce inflation, benefit their balance of payments, and spur recovery.

But the longer-run effects are more doubtful. Lower prices and uncertainty about the energy outlook could seriously impede many of the measures needed for secure energy supply for the coming decades. The current decline in oil exports is due in part to the economic recession as well as to the drawing down of inventories by oil firms in place of purchases. But it is also the result of energy conservation, recovery of more costly oil, and substitution of other fuels. All these changes, which have been promoted by the higher cost of oil, could be discouraged by a sharp fall in oil prices. Thus, with economic revival and depletion of oil inventories, the consequence could be another sharp rise in oil prices in the next year or so, made more severe by ''panic'' buying as in past crises.

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The point is that the international oil market is inherently volatile and subject to undue swings in response to relatively modest imbalance of current supply and demand. Such fluctuations do not reflect changes in underlying conditions of supply and demand, which are much slower and long term. Indeed this volatility in oil prices is damaging to both oil exporters and oil importers (though at different times) and serves the long-term interests of neither. Both would benefit from more stable prices corresponding to the basic conditions of supply and demand.

For the last three years an unofficial Group of Thirty, composed of well-qualified experts from both oil-exporting and oil-importing countries, has been studying these problems in an effort to identify common interests. A report prepared by the secretary of the group, Edwin A. Deagle Jr., taking account of the group's discussions (but not formally approved by its members) has just been released. It provides a clear analysis of the dilemmas. To cope with them, it suggests that oil exporters and importers should consult and seek to collaborate at least tacitly in smoothing out the more extreme fluctuations in oil prices. To the extent they could do so, prices would respond more accurately to the underlying economic factors and provide more appropriate guidance for both oil exporters and importers, especially in making investments and taking other longer-term measures affecting the supply and demand of oil and other energy sources.

The obstacles to such cooperation are obviously substantial. Distrust and resentment are deep-seated on both sides as a heritage of the past. OPEC's own members are hardly homogeneous (to say the least), and the major oil importers do not always concur in outlook and priorities. Moreover, specific price shifts up or down tend to benefit one side and harm the other. Finally, the immediate commercial interest of oil firms in acquiring or disposing of inventories tends to have a perverse effect - which accentuates the wide swings.

Even so, the suggestions regarding the managing of national stockpiles by oil importers in order to moderate price fluctuations are constructive and within their power, although difficult to apply. The report also makes some interesting proposals for improving oil market performance through financial measures to assist oil-importing developing countries to adjust to changing economic conditions, and to facilitate investment of surplus oil revenues by oil exporters in order to encourage output expansion to meet future demand. Finally, the report argues that the ability of oil exporters to coordinate the curtailing of output when demand falls serves the longer-term interests of oil importers as well as exporters. One idea not discussed is the persuasive proposal for tariffs on oil imports in order to compensate for price declines.

Clearly some of these proposals are controversial as well as complex to apply. But the basic stress of the report on the common interest in smoothing out erratic short-term fluctuations in the oil market, and on the necessity for active measures to do so, is convincing. It makes a persuasive case that leaving it to the market is not an adequate recipe for the problems.

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