Oil Prices—Who Are the Culprits?

Oil Prices—Who Are the Culprits?
June 11, 2008
Alvaro Vargas Llosa

WASHINGTON—Who is responsible for the astronomical price of oil? Most of the blame, as exemplified by the recent shenanigans in Congress with oil executives defending their paychecks under questioning by sanctimonious, eyebrow-raising legislators, is being put on petroleum companies. In European countries, protesters are denouncing the government for not taking immediate action to protect consumers. In newspapers from Hong Kong and Australia to Buenos Aires, traders responsible for the $260 billion currently invested in commodities funds are being condemned as “speculators.”

Actually, those are not the culprits. For years, countries endowed with oil, such as Russia, Venezuela and Mexico, have been messing up their own capacity to produce it by using it as a political weapon. That doesn’t mean that they are not producing millions of barrels each day, but it does mean that they are unable to increase production in order to keep up with demand—and traders do not expect them to raise the supply of oil in the future.

To make matters worse, monetary policy in the United States, the world’s largest economy, has been very loose for the last few years, helping fuel what some observers are calling an oil bubble.

If we also consider that in the last three decades the United States, representing a fourth of the world’s demand for oil, has seen its capacity to refine crude hampered because of environmental restrictions, what we have is, well, the price of gasoline shooting through the roof in America.

These causes all amount to one original sin: politicians interfering with the process of supply and demand, profit and loss. Adding insult to injury, we now have politicians throwing around proposals that will at best do nothing to cure the problem (tax holidays) and at worst (raising taxes on Big Oil, using antitrust legislation to stem “market concentration,” increasing subsidies for alternative fuels, controlling prices) will keep oil underground.

For a good part of his presidency, Vladimir Putin’s idea of fun was throwing the owners of big companies in jail and taking over their businesses. As a result, Rosneft and Gazprom, the energy giants controlled by the government, own more than half of Russia’s oil and gas reserves. Putin also raised taxes on oil profits to 90 percent. All of this gave the Russian potentate political and economic clout with which to blackmail European importers of Russian hydrocarbons and pressure neighboring countries such as Ukraine. When his country’s oil production rose to 9 million barrels a day, it looked like Putin was Midas. But at the same time, Russian technology was falling out of date and the capital investments needed to guarantee a healthy expansion of output were not being made. The result? Production fell this year for the first time. No wonder traders are “speculating” that Russia will not help lower the price of oil in the future.

A similar story can be told in Venezuela, where in recent years President Hugo Chavez has managed to bring oil production down by 1 million barrels, according to OPEC figures. The state oil company, PDVSA, is a key instrument of Chavez’s farcical Bolivarian Revolution, with billions of dollars being siphoned off to other countries rather than invested toward expanding output capacity. In Mexico, the Cantarell project, the world’s second-largest oil field, has seen its output nose-dive in recent years because the law does not allow private capital to sully the national honor with its thirst for profits.

But insufficient supply is not the only factor at play here. A number of economists, among them Paul van Eeden and Frank Shostak, argue convincingly that the Federal Reserve’s loose monetary policy between January 2001 and June 2004, and again since September 2007, has fueled inflation. In so doing, monetary policy has induced malinvestments in the economy—business ventures that would not have come into being otherwise and that have now boosted the demand for oil. Of course, in other countries, China in particular, inflation caused by monetary policy has also driven up demand for energy.

People are right to be angry. There is no reason why a barrel of oil should cost so much and why in an economy as productive as that of the United States people should be paying $4 plus for a gallon of fuel. Undoing the mistakes that took us to where we are will be costly and extremely unpopular. Placing the blame where it belongs is a way to start.


Alvaro Vargas Llosa
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Alvaro Vargas Llosa is Senior Fellow and Director of The Center on Global Prosperity at The Independent Institute. He is a native of Peru and received his B.S.C. in international history from the London School of Economics. He is widely published and has lectured on world economic and political issues including at the Mont Pelerin Society, Naumann Foundation (Germany), FAES Foundation (Spain), Brazilian Institute of Business Studies, Fundación Libertad (Argentina), CEDICE Foundation (Venezuela), Florida International University, and the Ecuadorian Chamber of Commerce. He is the author of the Independent Institute books The Che Guevara Myth and Liberty for Latin America.

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