December 6, 2001

Oil Weapon Myth

by Jerry Taylor and Peter VanDoren

Jerry Taylor is the Director of Natural Resource Studies at Cato Institute.

America has a lot to worry about right now, but one of the biggest worries haunting the intelligentsia is that our greed, our sloth, our self-indulgent lifestyle has given Islamic nations the economic equivalent of the nuclear bomb — the feared "oil weapon" — the existence of which is said to jeopardize our ability to vanquish terrorism in the Middle East.

Of course, there's debate about how best to take this potential weapon away from our enemies — kill caribou, kill SUVs, subsidize renewables, take your pick — but there's no debate from either the Left or Right about the economic firepower of the oil weapon or the need to disarm it. And that's too bad because, in fact, the oil weapon is a myth and belief in that myth is crippling U.S. foreign policy.

First, let's dispel the notion that we need to worry about an oil embargo directed at the United States. Once oil is in a tanker or refinery, there is no controlling its destination. During the 1973 embargo on the United States and the Netherlands, for instance, oil that was exported to Europe was simply resold to the United States or ended up displacing non-OPEC oil that was diverted to the U.S. market. Saudi oil minister Sheik Yamani conceded afterwards that the 1973 embargo "did not imply that we could reduce imports to the United States … the world is really just one market. So the embargo was more symbolic than anything else."

Second, OPEC is hardly in a position to punish the industrialized nations with a radical production cutback. That's because one of the main causes of instability in the region is declining oil revenues. Saudis who've gotten used to living on the state's generous oil dole, for example, are now finding that the dole has been cut by 70 percent since 1980 and that jobs are scarce. Because there's no other source of revenue for these economies other than oil, a major production cutback would bankrupt the OPEC countries and almost certainly trigger revolutions.

But would such a cutback hurt us more than it would hurt them? Well, the only reason we pay any attention to Arab political sentiment is because they've got oil. If they weren't selling oil, they'd have all the global political influence and military capability of, say, Uganda. That explains reports that al Qaeda recruitment tapes and captured documents implore terrorists to leave the Persian Gulf oil fields and tankers alone.

What if terrorists, however, did blow up refining or pipeline facilities to destabilize world oil markets and moderate Arab regimes? In the short run the relationship between supplies and price in oil markets is about 0.1. That is, a 1 percent reduction in supplies induces a 10 percent increase in price. In 1990 after the Iraqi invasion of Kuwait, world oil production decreased from 61 million barrels a day (mbd) to 56.5 mbd, or by about 7.4 percent. Oil prices increased from $18 to almost $31, or about 72 percent. World output is now 68 mdb, with the Mideast accounting for 21mbd (30.9 percent) and Saudi Arabia accounting for 8mbd (11.8 percent). So a complete Saudi shutdown would produce at least 120 percent increase in price (from $19 to almost $42) while a Mideast shutdown would produce over a 300 percent increase (from $19 to $76).

For those who think such prices are unimaginable, think again. We have already experienced them. The average cost of crude oil used by U.S. refineries in 1981 was $35.24. That is just over $60 at today's prices. To be sure, most Americans don't have fond memories of 1981, but we survived.

But what about a more modest cutback; say, a move to bring oil prices to $30-40 a barrel? Such prices are always possible, but there's little chance that OPEC could engineer them in today's economy. Demand is slumping because of a global economic downturn and major non-OPEC producers — Mexico, Norway, and Russia — do not appear to be interested in reducing output. Panic buying at the outset of a Middle Eastern war could conceivably deliver those prices, but production cutbacks probably could not.

But more to the point, politics has nothing to do with OPEC production decisions despite the ardent desire of the producing nations to have us believe otherwise. Oil economist M.A. Adelman argues that never once in OPEC's history has the cartel or any member in it left money on the table to pursue some political objective. When the Ayatollah Khomeini knocked off the Shah in 1979, the oil kept flowing. When U.S. bombs rained down on Libya's Muammar Qaddafi in 1986, the oil kept flowing. We had to impose an embargo on Iraq's Sadaam Hussein to get him to stop selling oil to the world market.

Moreover, there is not and has never been any correlation between OPEC "price hawks" and "price doves" and how those OPEC members felt about America or the industrialized West in general.

But even if you think that OPEC has the means and motive to use this alleged oil weapon, there's not a thing we can do about it. First, even if every drop of oil we consumed came from Oklahoma, Texas, and Alaska, a cutback in OPEC production would raise domestic oil prices as high as if all our oil came from Saudi Arabia. That's because there are no regional markets for oil — only global markets — and because prices always reflect opportunity costs in free markets, regional prices invariably rise to the world price. In 1979, for instance, Great Britain was "energy independent" — virtually all the crude oil it consumed came from the North Sea. But the oil price spike of 1979 hit Great Britain as hard as it hit Japan, a country dependent upon imports for its oil. No country can wall itself off from the world market.

The frequently heard call for accelerated deployment of renewable energy technologies is likewise silly. Even if there were some amazing technological breakthrough that allowed the market share of renewable energy to rise from its present 2 percent to, say, 40 percent, it wouldn't reduce oil imports a single drop. That's because renewable energy is a technology that generates electricity while oil is a fuel that powers vehicles and never the twain shall meet … at least not in the foreseeable future.

Nor would transportation-related energy-efficiency improvements, like increased CAFÉ standards for light trucks, have as much impact on oil imports as their proponents claim. That's because — all other things being equal — the more efficiently we use energy, the lower the marginal cost of consuming goods or services produced by energy. And if we lower the marginal costs of energy consumption, some of the potential energy savings will disappear because of an increase in vehicle miles traveled.

But if we could stick to such an economic diet, wouldn't using less oil reduce Arab oil revenues and thus prove a useful patriotic act? It's hard to see how. Declining oil revenues increase instability in moderate Arab states and thus make more likely bin Laden takeovers in countries such as Saudi Arabia.

Fear of the oil weapon has unduly affected our foreign policy, provided cover for an endless host of subsidies and preferences, and is repeatedly marshaled to support policy agendas from both the Left and Right that can't otherwise stand on their own two feet. The sooner we get over this fetishistic loathing of oil imports, the better.

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