Krugman: The Third Oil Crisis?

Michael Pollak mpollak at panix.com
Wed Apr 10 17:49:37 PDT 2002


New York Times April 9, 2002

The Third Oil Crisis?

By PAUL KRUGMAN

I n 1973 an Arab embargo sent oil prices soaring, and a global

recession followed. In 1979 the Iranian revolution provoked a second

surge in oil prices, and another global recession.

Are we now at risk of a third oil crisis? I wish I could say no, but I

can't.

Oil prices have risen about $10 per barrel since the situation in the

Middle East began deteriorating. So even if they stay where they are,

this represents a serious shock to the system and there could be more

to come.

True, political analysts assure us that despite Iraq's decision to

stop oil exports for a month, no broader, 1973-style oil embargo is

likely. Let's hope they're right. But the 1979 oil crisis wasn't the

result of a deliberate embargo.

Economists have never reached a consensus about what happened in 1979,

but my interpretation is that it was similar to the recent California

electricity crisis. In both cases the key was the combination of a

tight market and demand that wasn't very responsive to price. Under

those circumstances, individual producers power companies in

California, oil-producing countries in 1979 have a lot of market

power. That is, it is in each producer's interest to cut back

production to drive prices higher. The result is a price surge, even

though there is no real capacity shortage.

Are world oil markets that tight? Not yet the world still has about

seven million barrels' worth of spare capacity each day. So Iraq, by

taking away its two million barrels a day, cannot create a crisis by

itself. But the remaining slack in the system is just about equal to

the combined production of Iran and Libya, which have also proposed an

embargo.

The point is that it would not take much worsening in the political

situation to produce markets so tight that the logic of market power

kicks in and countries decide that, quite aside from politics, their

financial interest lies in reducing, not increasing, their output.

If an oil crisis can happen so easily, why haven't we had one since

1979? The answer is that we made ourselves crisis-proof for a while,

then became complacent. After the oil crises of the 1970's, Western

economies sharply increased their energy efficiency: the U.S. economy

was a third bigger in 1985 than it was in 1973, but it consumed less

oil. The result was the marginalization of the danger zone: in 1985,

the Persian Gulf produced only 18 percent of the world's oil, less

than half of its share in 1973. But rapidly growing oil consumption in

the S.U.V. era was met, inevitably, by increased Persian Gulf

production. So oil prices are once again hostage to Middle Eastern

politics.

If oil prices do surge, will this have the same disastrous effects as

the price spike in 1979? No, but it may have different disastrous

effects.

In 1979 the clear and present danger from soaring oil prices was that

they would send already inflation-prone Western economies into an

out-of-control inflationary spiral. To fight that, all the leading

economies raised interest rates which controlled inflation, but also

generated a nasty recession.

Today, after a decade of price stability, fears of inflation are much

more muted. Instead, the main concern is the drag of oil prices on

purchasing power. Each $10-per-barrel increase in the price of oil is

like a $70 billion tax increase, one that falls most heavily on

middle- and lower-income families.

And this is not a good time to slash purchasing power. Business

investment, which plunged last year, has still not recovered;

optimistic economic forecasts depend on the assumption that buoyant

consumer spending will keep the economy afloat until businesses do

decide to invest again. If consumers are made poorer by higher oil

prices and cut back instead, that assumption goes out the window. And

the Fed can't respond with another big round of interest rate cuts:

since it has already reduced rates from 6.5 to 1.75 percent, it

doesn't have much ammunition left.

So I'm sorry to say that under current conditions, a third oil crisis

could indeed happen. It doesn't have to happen: a diplomatic

breakthrough could calm oil markets, and even if oil prices rise, the

U.S. economy may be more robust than I fear. But it's easier to tell a

downbeat, even scary, story than any of us would like.

Copyright 2002 The New York Times Company



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