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