Fallacies in U.S. Oil Policy

Fallacies in U.S. Oil Policy 
August 27, 2009
Ivan Eland
Pittsburgh Tribune-Review

The sight of convicted terrorist Abdel Basset Ali al-Megrahi getting a hero’s welcome in Libya after murdering 270 people in the 1988 bombing of Pan Am Flight 103 over Lockerbie, Scotland, was repugnant.

Although Scotland released Megrahi because he allegedly has terminal prostate cancer, there may have been another reason: because the United Kingdom wants to curry favor with oil-rich Libya.

In this regard, the United States has no room to talk.

About 150 years ago, on Aug. 27, 1859, Col. Edwin L. Drake drilled the world’s first oil well near the tiny Pennsylvania hamlet of Titusville. The industry boomed and the town grew from a population of 250 to 10,000 in 1866.

Since then, the U.S. and other governments have developed an unhealthy obsession with oil as an allegedly “strategic” commodity.

Although President Obama and other U.S. officials expressed outrage at the hero’s welcome given Megrahi, the United States for decades has coddled one of our top oil suppliers, Saudi Arabia, a country that has one of the worst human rights records on the planet, promotes radical Islam around the world, and looks the other way while Saudi citizens fund terrorist groups that plot against the United States.

The United States does so because Saudi Arabia has the largest oil reserves in the world and is the leader of OPEC, the international oil-exporting cartel. So for nearly 70 years—since Saudi Arabia’s founder, King Abdul Aziz Al Saud, met with President Franklin D. Roosevelt in 1945—the United States and Saudi Arabia have had an implicit understanding: the U.S. protects the regime and its oil fields and it ensures continued access to oil.

This policy is based on several fallacies.

The first fallacy is that oil is so strategically important that it can’t be left to the market.

To the contrary, the market is the best way to assure supply. In a market, if there is a disruption of oil supplies because of war, natural disaster or another calamity, the price will go up. When prices increase, oil producers have an incentive to pump more oil because they can make more money. Problem solved.

In an attempt to keep oil prices excessively high, the OPEC cartel sets production quotas for each producer. Whenever prices go up, however, producers routinely exceed their quotas. Such cheating has made OPEC a paper cartel, unable to hold long-term prices above what the market will bear.

The United States essentially is paying Saudi Arabia—indirectly through the provision of security—to do what it would do anyway during a crisis: increase production. Saudi Arabia also has an incentive to see that prices don’t remain too high too long because such prices could lead to permanent reductions in demand, as consumers conserve and switch to alternative fuels.

A second fallacy is that the U.S. military presence in the Persian Gulf increases the security of oil supplies. In fact, America is seen in that part of the world as an “infidel”—and our military presence on Islamic soil riles radical Islamists, increasing instability. While the Saudis want the U.S. security umbrella, they understand this threat. That’s why they sent most U.S. troops packing before the U.S. invaded Iraq. They want the security as long as the U.S. provides it from offshore.

The third fallacy is that low oil prices are necessary for our economy to function efficiently. There is no evidence that industrial economies go into a tailspin when oil prices go up. The stagflation of the 1970s was caused by poor government monetary policy and price controls, not by the oil price shocks. The current recession also was precipitated by bad monetary policy, not oil prices. If anything, the U.S. economy has become more resilient to oil shocks because the cost of oil now makes up only 3 percent of GDP, half of what it was in the 1970s.

Instead of coddling oil-producing tyrants like Moammar Gadhafi and the Saud family, the United States and other industrial countries should let the market work. We should not pay a premium for oil by sacrificing our principles or pursuing unnecessary, costly and counterproductive military activities.

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Ivan Eland
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Ivan Eland is Senior Fellow and Director of the Center on Peace & Liberty at The Independent Institute. Dr. Eland is a graduate of Iowa State University and received an M.B.A. in applied economics and Ph.D. in national security policy from George Washington University. He has been Director of Defense Policy Studies at the Cato Institute, and he spent 15 years working for Congress on national security issues, including stints as an investigator for the House Foreign Affairs Committee and Principal Defense Analyst at the Congressional Budget Office. He is author of the books Partitioning for Peace: An Exit Strategy for Iraq, and Recarving Rushmore.
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