Bush's New Drilling Proposal

President Bush has formally called on Congress to lift its ban on off-shore drilling and on-shore drilling in previously restricted areas such as the Alaska National Wildlife Refuge, the big argument can officially begin. On one side, E&P companies will argue that US national security depends on producing oil from US holes, thereby making the US less dependent on foreign oil. On the other side, the argument is that the US can not drill itself out of the current supply/demand imbalance.

Around the nucleus of these two arguments other important issues will be spun like so many electrons: OPEC's power, speculation, global warming. Let's examine each of these briefly.
OPEC countries supply about 40% of the world's crude oil. That is not a monopoly. If it were, OPEC could simply set the price of oil at whatever level it chose and everyone would have to pay that price. The coming meeting between producer and consumer countries is evidence that OPEC believes that crude prices are too high and are permanently destroying demand for the cartel's only asset. OPEC's claim that the market is well-supplied is mostly true, but it's not the whole story.

Many commentators blame speculation for the dramatic run-up in crude prices over the past year. The big price moves do not indicate monopoly pricing. Crude prices are moving up because demand growth is outstripping supply growth. It is likely that non-commerical traders are contributing to high crude prices, but barring evidence of significant market manipulation, it's hard to see how speculation alone caused prices to double in a year.

Current opinion polls indicate that between 60% and 80% of the American public believes the US should eliminate all, or most, restrictions on exploration for new sources of US crude oil. Exxon (NYSE:XOM) and Chevron (NYSE:CVX) executives have recently urged the Congress to do just that. New drilling might help, but not for at least ten years; and by then, demand will likely have overtaken supply by an even wider margin.

Still, the US might want to consider opening up restricted areas to new drilling, but not under the same rules that have been in place for the past hundred years. If US lawmakers can bring themselves to force drillers to internalize the full cost of crude oil, then it might make sense to allow new drilling. The largest change would be to include the now externalized cost of carbon emissions. Such a change would demonstrate that the US does not expect the rest of the world to assume the cost of increasing greenhouse gas emissions. Furthermore, the funds collected, either through a cap-and-trade scheme or a carbon tax, should be spent on developing renewable sources of energy.

None of this does much to reduce gasoline pump prices in the short term. In fact, prices probably won’t fall even in the long term. But by allowing more drilling at full cost, and by increasing development of new and cleaner fuels, the US puts itself in a strong leadership position from which it can encourage other consuming nations to adopt similar policies.

Paul Ausick