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CAPITALISM:
A Treatise on Economics

by
George Reisman


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Why the Price of Oil Is Surging*

By

George Reisman**

Over the last year, the price of oil has once again been surging. The most prominent immediate cause has been cutbacks in the production of oil on the part of the member countries of OPEC, such as Saudi Arabia and Kuwait. But there are other and deeper causes at work, just as there were in the 1970s, when the price of oil dramatically increased.

First, the government of the United States was and is bent on a reckless expansion of the money supply. This acts to raise the demand for everything and thus the price of everything. Until recently, the main effect of the current rapid expansion in the quantity of money was to drive up stock prices and then real estate prices. But now it is spreading to commodity prices, oil in particular. It is only an expansion in the quantity of money and the corresponding increase in the overall ability to spend money that enables people to make sharply increased expenditures for oil and oil products without having to equivalently reduce their expenditures for other things and thereby reduce the prices of a wide range of other things.

And second, it is the U. S. government, no less than the governments that are members of the international oil cartel, that was and is responsible for the reduction in the supply of oil.

The U.S. government, acting largely under the influence of the ecology movement, has restricted the supply of oil in the following ways: (1) It has prevented exploration for and development of oil reserves in vast areas of territory arbitrarily set aside as “wildlife preserves” or “wilderness areas.” It has even consistently sought to prevent the development of the vital North Slope Alaskan oil fields, on the grounds of alleged concerns over harmful “environmental” effects, such as disturbance of the feeding habits of caribou herds and deterioration in the appearance of frozen waste lands. (2) It has joined in an international agreement to close Antarctica and its potentially vast oil deposits to all mining operations for the next fifty years. (3) It has prevented the development of offshore oil wells on the continental shelf. (4) It has prevented the construction of oil and gas pipelines, of new refineries, oil storage facilities, and facilities for handling supertankers. (5) Over the years, the U.S. government has imposed price controls on oil and has acted further to restrict oil company profits, and thus oil industry investment, by punitively increasing their rate of taxation through first reducing and then totally abolishing the old depletion allowance on crude oil.

In addition, the U.S. government has been responsible for an enormous artificial increase in the demand for oil, over and above the increase caused by its policy of inflation. It has caused this artificial increase in demand mainly by holding down the supply of substitutes for oil, such as atomic power and coal. In these ways, it forced, and continues to force, the demand for fuel to rely more heavily than necessary on oil supplies. Like reductions in the supply of oil, these measures also increase the scarcity of oil.

In sum, the government and the ecology movement have done everything in their power to raise the demand for and restrict the supply of oil.

It should be realized that it was only these actions of the U.S. government that has made possible the dramatic rise in the price of oil—in the 1970s and again today. The U.S. government bears a far greater responsibility than the Arab cartel. It is the party that has made it possible for the cartel to succeed. All that the cartel did in the 1970s, and is once again doing now, is to take advantage of the artificial increase in demand and reduction of supply brought about by the U.S. government.

Had the U.S. government not restricted the expansion of the domestic petroleum industry and forced up the demand for oil, the supply reductions carried out by the cartel would not have had such a significant effect on the price. Because in that case, such supply reductions would have been at the expense of far less important wants than actually turned out to be the case. With the larger domestic supply of oil and competing fuels that a free market would have produced, the importance of any given amount of oil would have been far less. The loss of any given amount of oil by virtue of the supply reductions carried out by the cartel would therefore have been much less serious. (An analogy would be the difference between someone having to give up a scoop of ice cream when he has three or four scoops compared with when he has only two scoops.) As a result, the cartel would not have been able to raise the price nearly as much by virtue of any given amount of supply reduction.

In such circumstances, in order to establish a price of crude oil as high as existed back in the 1970s, or as high as exists today, the cartel members would have had to reduce their production far more than they actually did reduce it. They would have had to reduce their production by an additional amount equal to the sum of the reduced supply and increased demand for oil caused by the policies of the U.S. government. This would have been too great a loss of volume for the cartel to be able to benefit from the high price.

Furthermore, in the absence both of environmental restrictions on the supply of domestically produced oil and of controls on the price of such oil, any rise in the price of oil achieved by the cartel would work to the advantage of the American oil industry at the expense of the oil industry in the countries belonging to the cartel. This alone would be enough to frustrate the plans of the cartel. For in this case, the effect of the cartel's reduction of supply would be to hand the American oil industry the profits and the capital required for an expansion of supply. The cartel would then either have to allow the price of oil to fall or else it would have to restrict its own production still further, which would mean that the American oil companies would earn the high price of oil on a larger volume of production and have still greater profits available for expansion, thereby creating still worse problems for the cartel in the future.

It should be obvious that it is impossible for any cartel to succeed that is confronted with a major competitor able to profit from its policies and expand his production. The Arab cartel was and is able to succeed only because the U.S. government did, and continues to do, its utmost to prevent the cartel's competition—the U.S. oil industry—from earning high profits and expanding. Although it was and is certainly not their intent, those elected officials who have been setting the U.S. government’s energy policy for much of the last thirty years have behaved as though they owed their election to voters in the member countries of the Arab cartel, rather than to voters in the United States. For it has certainly not been an American constituency that their actions have served, but the interests of the Arab cartel.

In the absence of the U.S. government's misguided policies, the Arab cartel would probably never even have been formed in the first place, because the conditions required for its success would have been totally lacking. If, today, the United States were to abolish its restrictions on the production of energy and abstain from enacting price controls and any other punitive measures against the American oil and other energy-producing industries, the OPEC cartel would be broken once and for all, and the real price of energy would resume the descent it enjoyed from the start of the Industrial Revolution until the 1970s.

Such a policy, of course, would entail removing the prohibitions on the construction of atomic power plants and the restrictions on the strip mining of coal. It would also entail the privatization of the vast landholdings of the federal and state governments in Alaska and the other Western states and of the continental shelf, and then fully respecting the right of the new private property owners to use their property as they saw fit, so that oil, coal, and gas reserves and atomic power could all be freely developed. That would be a policy of abundant and cheap energy in all of its forms. It would be a policy that would operate in favor of  the American consumer, not the Arab governments that control substantial oil reserves.


This article appeared in the Commentary Section of The Orange County Register, Sunday, April 2, 2000.

*Copyright © 2000 by George Reisman. All rights reserved.

**George Reisman, Ph.D., is professor of Economics at Pepperdine University’s Graziadio School of Business and Management and is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). 

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