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Feb 21, 2012

The Oil Market Panic

Fred:  Gas prices are going up. The oil companies are gouging us.
Mike:  Iran's desire for nuclear weapons is shaking up the Middle East. Oil companies are just mice among the elephants.

Fred:  Well, the government should limit the price.
Mike:  Do you want shortages, rationing, and two-hour lines at $3.00 per gallon, or to adapt in your own way at $4.50 per gallon? You are going to use less gas either way.

The Oil Market Panic
02/20/12 - Hoover.org by Richard A. Epstein

[edited and paraphrased]:  The rise in oil prices traces to a renegade Iran. The West sees that the Iranian nuclear threat is not just bluster. Iran poses far greater risks to world peace and the political order than even a major disruption in oil supplies.

An anxious West is making a concerted, effective effort to cut off Iran from the world’s banking system and to block the international use of Iranian oil. The Saudis have helped the West by expanding their shipments into world markets. One-third of world oil travels through the Strait of Hormuz. The Iranian threat to close the Strait and the movement of the U.S. aircraft carrier Abraham Lincoln into the Strait are serious.

These developments have driven the price of North Sea Brent crude oil to around $119 per barrel, a potential gasoline price of $4.25 per gallon. Ordinary Americans are being forced to tighten their belts. The best response is to allow this free-market adaptation to reality. A worse response is for the government to undermine the market by capping price increases or dictating its vision of the right price.

Any system of government subsidies or controls will disrupt the vital market process of continuous adaptation. It will also cost a fortune. The “hands off” motto of laissez-faire capitalism has never been more pertinent than in this oil crisis. Government interference in the market will make the effects worse.

Leading political figures on both sides have responded sophomorically. Their shared, incorrect premise is that price changes are evidence of a market failure, and this justifies intervention. It doesn't. Price increases should not lead to a call for price limits.

The real problem is the trouble brewing in Iran and the Strait of Hormuz. Politicians should neither panic nor pander. Their political energies are needed to reach a diplomatic or military solution for a serious international breakdown that requires our urgent and unified national attention.

The current rise in US oil and gasoline prices comes from reasonable fear of a conflict with Iran, and the current attempt by the US and other countries to cut off Iran's income through buying less Iranian oil, to pressure an agreement on nuclear weapons. This necessarily increases oil prices, but hopefully this will be less expensive than going to war.

This price increase is not primarily Obama's fault. But, we can rightfully blame him for denying the US much productive work and jobs developing the huge US oil reserves, and for refusing to make the US less dependent on foreign sources.

Development of domestic oil would not completely change the world oil price. Oil is an international commodity. But, a large domestic supply would more insulate the US from threats to foreign supplies.

We rely now on the  Strategic Petroleum Reserve, storing 726 million barrels of oil, to back up US consumption of 21 million bbl/day (34 days usage). It would be much better if the US were producing that 21 MMbbl domestically, rather than the current 5.8 MMbbl/day.

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