By William R Edwards

The following article was written for MEES by Mr Edwards, who is President of Edwards Energy Consultants, Katy, Texas (wre@texven.com).

The current oil price disruption is not a supply problem. It is a psychological problem. All competent assessments agree that sufficient spare producing capacity exists to cover any loss of production from producers affected by political turmoil. The recent upward price spiral is simply the result of speculative hysteria fuelled by sensationalism-seeking news organizations.

In order to avoid overreacting or taking unwise actions, those in leadership positions should first be grounded in the simple arithmetic of oil supply/demand balances. The ability of Saudi Arabia to add an additional 4mn b/d to world supplies will cover any but the direst loss of producing capacity elsewhere. For example, the complete loss of Libyan production can be made up with only a third of the Saudi spare capacity. While minor timing and quality dislocations may occur, these inconveniences can be ameliorated with a cost of a few cents per barrel to the system, not the $10/B or $20/B jump that prices have already experienced.

In a perfect world the responsible producers of oil would resist the temptation to capitalize on the hysteria and hold steady their prices at reasonable levels. But the world is not perfect. Not only are producers unwilling to decline to accept the windfall being offered them, in fact they aren’t sufficiently competent in price management to know how to hold a steady price. The result is the ‘follow the leader’ mentality that allows prices to move up behind the speculative futures leadership.

This situation presents an attractive opportunity to political leadership. Although they may not understand the whys and wherefores of the simple arithmetic of supply and demand, they can read the inherent discomfort of their constituents that calls for something to be done to quell the rip-off of the consumer. Thus the prospect of government control rears its ugly head.

If the producing countries are unable to be self-policing, then the various governmental bodies in the consuming countries are quite willing to step in to ‘save the consumer’. And even though we hate to admit it, there is some justification for such action. Most observers agree that extreme price volatility is bad for the economy and the business. Thus effective steps to minimize price instability would seem to be justified. Since the basic problem is not based on supply/demand or free market fundamentals, but instead is based upon speculatively inspired psychological perception, remedial action based upon similar factors seems appropriate.

The 800 pound gorilla in the room is import price controls. In reality, if the major consuming countries enacted a price ceiling on imports and were able to utilize existing strategic reserves to overcome any timing problems, the producers of the world would have no choice but to comply with the dictated price ceilings. They might resist for a time, but with no other outlet for their production, eventually all would abandon their resistance. Magically, oil prices would be set by consuming countries rather than producing countries at levels much below those recently experienced.

Who knows if President Obama is sufficiently perceptive to recognize the benefits of this potential action? The fact is that an immediate 25-50% reduction in gasoline prices in his country would almost surely insure his reelection. How could he resist this opportunity?

If the producers of the world wish to avoid the consumer price control threat, immediate action is required. However if inertia and confusion are allowed to continue, it is quite likely that, in the near future, the golden goose will be decapitated.