How to Lower Oil Prices Now and in the Future

Last week, Barack Obama and his ideological fellowship mocked John McCain after the Senator stated that opening up domestic oil exploration would have an immediate negative impact on oil prices, primarily because of psychological reasons, long before the first barrel is pumped (Obama Assails Remarks by McCain on Offshore Oil Drilling). Unfortunately for Obama and his minions, such attacks go a long way in proving that none of them have even an elemental understanding of how markets, including the oil markets, work.

Ultimately, markets are driven by supply and demand. But economists and scientists have known for years (centuries, even) that severe market swings, both upwards and downwards, have a life somewhat independent of supply and demand. At their core, human beings, their emotions, and their subconscious behavior patterns primarily drive those severe swings. Call it "panic", refer to it as "jumping on the bandwagon" -- it exists, it is a component of today's oil prices, and it can be addressed.

For evidence of this "psychological component" of the markets we can look way back to books like "Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay published in 1841, or to more mid 20th Century works such as this article from 1962 in Time Magazine, Emotions & the Market. More recently, we have "Manias, Panics, and Crashes: A History of Financial Crises" from 2005, written by Charles P. Kindleberger. Kindleberger does a wonderful job of describing the various stages surrounding a financial crisis, boom, or bust - stages which inevitably lead to first mania, then panic.

But as much as we can easily refute Obama's infantile attacks on McCain by using those works and many more like them, today we're dealing with the question of oil. Namely, would the mere opening of new domestic oil exploration create an immediate downward pressure on oil prices?

For that we turn to an op-ed in the Wall Street Journal by Martin Feldstein, We Can Lower Oil Prices Now. Mr. Feldstein was the Chairman of the Council of Economic Advisers under President Ronald Reagan, is currently a professor at Harvard, and is also the President of the National Bureau of Economic Research.

In his editorial, Mr. Feldstein quickly dismisses the idea, proffered by Democrats, that pure financial speculation explains the current dramatic rise in energy and food prices worldwide. He first discusses perishable agricultural commodities (specifically corn), noting that demand has greatly increased from China, India, other third world countries, and also from the need for ethanol as a fuel additive. This increase in demand all happened rather quickly, and the supply sector has yet to catch up. But since corn is a food staple for billions of people, supply will catch up (people will plant more) and prices will stabilize.

Feldstein then tackles oil, a more complicated subject because of the politics involved. He offers a simple and concise explanation on how oil suppliers choose to increase supply (and therefore reduce price). It's based on several factors, not the least of which is the expected future demand and supply from the countries that control their own oil production. Unlike corn, with oil we're caught in a political struggle that limits production within the United States. The rules of supply and demand still hold, but one particular political party intentionally and artificially limits domestic supply. That takes control of prices literally out of our hands, and when that is coupled with future predictions of demand outpacing supply worldwide, we have what we see today in escalating oil prices. The obvious solution to counter the rising prices -- do something domestically ourselves, and now. We might not see a drop of new oil for a year, three years, or five years -- but we will again control our energy future, and the price of oil and gasoline. From Feldstein's piece:

The relationship between future and current oil prices implies that an expected change in the future price of oil will have an immediate impact on the current price of oil.

...Once this relation is understood, it is easy to see how news stories, rumors and industry reports can cause substantial fluctuations in current prices - all without anything happening to current demand or supply.

By actively letting the world markets know that we are resolved to take care of our own future energy needs, we are directly combating the rise in oil prices. Such a message isn't (and shouldn't be) limited to just pumping more oil. To be most effective, the message should include the fact that we are actively developing methods to reduce our consumption of oil, while at the same time increasing our domestic supply of oil. More from Feldstein:

Now here is the good news. Any policy that causes the expected future oil price to fall can cause the current price to fall, or to rise less than it would otherwise do. In other words, it is possible to bring down today's price of oil with policies that will have their physical impact on oil demand or supply only in the future.

For example, increases in government subsidies to develop technology that will make future cars more efficient, or tighter standards that gradually improve the gas mileage of the stock of cars, would lower the future demand for oil and therefore the price of oil today.

Similarly, increasing the expected future supply of oil would also reduce today's price. That fall in the current price would induce an immediate rise in oil consumption that would be matched by an increase in supply from the OPEC producers and others with some current excess capacity or available inventories.

Obviously, working on more efficient cars for the future does nothing for the oil and gasoline currently used by the 247,421,120 cars estimated to be in use today within the United States. The increased price of gasoline will probably cause many people, especially the poor, to drive a little bit less. But most people don't have the means to go out and immediately buy a more efficient automobile (again, especially the poor), so it's safe to assume that our demand for gasoline over the next few years, if not decades, is not going to recede much, if at all.

That means that the only option we have to negatively affect the price of gasoline immediately is to open up more of our own oil fields for exploration and drilling. I'm not referring to the Democrats plan' to force oil companies to drill dry holes in presently leased lands that revert back to the government in a few years, but allowing those companies to drill in new areas where there is oil - offshore, in the Midwest, and in ANWR.

Are we going to see $2.00 a gallon gasoline again? Probably not. But it seems as if reaching the $4.00 a gallon price triggered some primal emotion in American consumers. They want answers and help, now.

Only one party has a credible solution to today's energy crisis, and that's the Republicans. Open up more areas for domestic oil production, demand that Congress fast track the approval process for nuclear power plants, and invest money in renewable energy technology that might be an affordable replacement for other significant energy sources in couple of decades. Those are two solutions that give us more affordable energy immediately, and one solution that might give us affordable energy in the future.

The Democrats? Regardless of how many people they try to blame for high energy prices, that's all they have in their quiver -- the blame arrow. Barack Obama and his fellow Democrats are happy with the higher energy prices and they don't intend to do anything about it. Obama is on record (see YouTube video here) as saying that the solution to current high energy prices is ending the war in Iraq (of course, that's the key to everything), and investing $60 billion to switch America from a "car culture" to a "mass transit culture"!

Books can be written on what's wrong with Obama's plans. Suffice to say that it doesn't help anyone today, or for the next few decades. And the American public will never go along with it. Add to that the fact that the sole nationwide mass transit system we have now (Amtrak) is both an abject failure and hemorrhaging money (requiring constant taxpayer bailouts). Just one tunnel project in Boston cost $14.8 billion over 10 years starting in the 90s, so Obama's $60 billion figure is a ridiculous figure for transforming our transportation system to heavy reliance on mass transit.

Come to think of it, perhaps the aforementioned Mackay tome from 1841, "Extraordinary Popular Delusions and the Madness of Crowds", describe Barack Obama and his followers quite well.
Last week, Barack Obama and his ideological fellowship mocked John McCain after the Senator stated that opening up domestic oil exploration would have an immediate negative impact on oil prices, primarily because of psychological reasons, long before the first barrel is pumped (Obama Assails Remarks by McCain on Offshore Oil Drilling). Unfortunately for Obama and his minions, such attacks go a long way in proving that none of them have even an elemental understanding of how markets, including the oil markets, work.

Ultimately, markets are driven by supply and demand. But economists and scientists have known for years (centuries, even) that severe market swings, both upwards and downwards, have a life somewhat independent of supply and demand. At their core, human beings, their emotions, and their subconscious behavior patterns primarily drive those severe swings. Call it "panic", refer to it as "jumping on the bandwagon" -- it exists, it is a component of today's oil prices, and it can be addressed.

For evidence of this "psychological component" of the markets we can look way back to books like "Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay published in 1841, or to more mid 20th Century works such as this article from 1962 in Time Magazine, Emotions & the Market. More recently, we have "Manias, Panics, and Crashes: A History of Financial Crises" from 2005, written by Charles P. Kindleberger. Kindleberger does a wonderful job of describing the various stages surrounding a financial crisis, boom, or bust - stages which inevitably lead to first mania, then panic.

But as much as we can easily refute Obama's infantile attacks on McCain by using those works and many more like them, today we're dealing with the question of oil. Namely, would the mere opening of new domestic oil exploration create an immediate downward pressure on oil prices?

For that we turn to an op-ed in the Wall Street Journal by Martin Feldstein, We Can Lower Oil Prices Now. Mr. Feldstein was the Chairman of the Council of Economic Advisers under President Ronald Reagan, is currently a professor at Harvard, and is also the President of the National Bureau of Economic Research.

In his editorial, Mr. Feldstein quickly dismisses the idea, proffered by Democrats, that pure financial speculation explains the current dramatic rise in energy and food prices worldwide. He first discusses perishable agricultural commodities (specifically corn), noting that demand has greatly increased from China, India, other third world countries, and also from the need for ethanol as a fuel additive. This increase in demand all happened rather quickly, and the supply sector has yet to catch up. But since corn is a food staple for billions of people, supply will catch up (people will plant more) and prices will stabilize.

Feldstein then tackles oil, a more complicated subject because of the politics involved. He offers a simple and concise explanation on how oil suppliers choose to increase supply (and therefore reduce price). It's based on several factors, not the least of which is the expected future demand and supply from the countries that control their own oil production. Unlike corn, with oil we're caught in a political struggle that limits production within the United States. The rules of supply and demand still hold, but one particular political party intentionally and artificially limits domestic supply. That takes control of prices literally out of our hands, and when that is coupled with future predictions of demand outpacing supply worldwide, we have what we see today in escalating oil prices. The obvious solution to counter the rising prices -- do something domestically ourselves, and now. We might not see a drop of new oil for a year, three years, or five years -- but we will again control our energy future, and the price of oil and gasoline. From Feldstein's piece:

The relationship between future and current oil prices implies that an expected change in the future price of oil will have an immediate impact on the current price of oil.

...Once this relation is understood, it is easy to see how news stories, rumors and industry reports can cause substantial fluctuations in current prices - all without anything happening to current demand or supply.

By actively letting the world markets know that we are resolved to take care of our own future energy needs, we are directly combating the rise in oil prices. Such a message isn't (and shouldn't be) limited to just pumping more oil. To be most effective, the message should include the fact that we are actively developing methods to reduce our consumption of oil, while at the same time increasing our domestic supply of oil. More from Feldstein:

Now here is the good news. Any policy that causes the expected future oil price to fall can cause the current price to fall, or to rise less than it would otherwise do. In other words, it is possible to bring down today's price of oil with policies that will have their physical impact on oil demand or supply only in the future.

For example, increases in government subsidies to develop technology that will make future cars more efficient, or tighter standards that gradually improve the gas mileage of the stock of cars, would lower the future demand for oil and therefore the price of oil today.

Similarly, increasing the expected future supply of oil would also reduce today's price. That fall in the current price would induce an immediate rise in oil consumption that would be matched by an increase in supply from the OPEC producers and others with some current excess capacity or available inventories.

Obviously, working on more efficient cars for the future does nothing for the oil and gasoline currently used by the 247,421,120 cars estimated to be in use today within the United States. The increased price of gasoline will probably cause many people, especially the poor, to drive a little bit less. But most people don't have the means to go out and immediately buy a more efficient automobile (again, especially the poor), so it's safe to assume that our demand for gasoline over the next few years, if not decades, is not going to recede much, if at all.

That means that the only option we have to negatively affect the price of gasoline immediately is to open up more of our own oil fields for exploration and drilling. I'm not referring to the Democrats plan' to force oil companies to drill dry holes in presently leased lands that revert back to the government in a few years, but allowing those companies to drill in new areas where there is oil - offshore, in the Midwest, and in ANWR.

Are we going to see $2.00 a gallon gasoline again? Probably not. But it seems as if reaching the $4.00 a gallon price triggered some primal emotion in American consumers. They want answers and help, now.

Only one party has a credible solution to today's energy crisis, and that's the Republicans. Open up more areas for domestic oil production, demand that Congress fast track the approval process for nuclear power plants, and invest money in renewable energy technology that might be an affordable replacement for other significant energy sources in couple of decades. Those are two solutions that give us more affordable energy immediately, and one solution that might give us affordable energy in the future.

The Democrats? Regardless of how many people they try to blame for high energy prices, that's all they have in their quiver -- the blame arrow. Barack Obama and his fellow Democrats are happy with the higher energy prices and they don't intend to do anything about it. Obama is on record (see YouTube video here) as saying that the solution to current high energy prices is ending the war in Iraq (of course, that's the key to everything), and investing $60 billion to switch America from a "car culture" to a "mass transit culture"!

Books can be written on what's wrong with Obama's plans. Suffice to say that it doesn't help anyone today, or for the next few decades. And the American public will never go along with it. Add to that the fact that the sole nationwide mass transit system we have now (Amtrak) is both an abject failure and hemorrhaging money (requiring constant taxpayer bailouts). Just one tunnel project in Boston cost $14.8 billion over 10 years starting in the 90s, so Obama's $60 billion figure is a ridiculous figure for transforming our transportation system to heavy reliance on mass transit.

Come to think of it, perhaps the aforementioned Mackay tome from 1841, "Extraordinary Popular Delusions and the Madness of Crowds", describe Barack Obama and his followers quite well.