OVERVIEW - THE REALITY OF OIL PRICES

As discussed on the "Crude Oil" page, oil is the life blood of the economy.  Therefore, it follows that the price of oil affects the cost of everything that:

• is made from oil byproducts
  
• is fueled by oil byproducts
  
• is lubricated by oil byproducts
  
• is packaged in materials made from oil byproducts
  
• involves transport by vehicles fueled by oil byproducts.
  

Despite these realities, almost no one in politics is talking about the fact that the dramatic increase in oil prices is a primary driver in the current economic slow down that America is experiencing.  Here are a few facts to consider:

• Every additional dollar spent on oil or its byproducts is less money for consumers to spend on other products and services that drive the economy, or to meet their mortgage and other debt obligations. 
  
• Lower consumer spending and the fears of it:
• Cause firms to reduce manufacturing and service capacity along with related employment.
• Cause companies to reduce capital spending that is also a driver of economic growth.
• Is a large contributing factor in the drop in stock market values.
  

A History of Oil Prices per Barrel vs Euro/Dollar Exchange

Oil prices have risen dramatically since May 2003, and they are a major contributing factor to the current economic slow down.  Please consider the following data:

                                                  %       Euro/           %
                              Oil Price  Change  Dollar     Change

• May 2003     $22.00                   1.2877     
• Nov. 2006     $59.00     168%    1.2762     (1.15%)
  
• July 2008    $145.00     146%    1.5716      23.1%
• Total Change               559%                     21.9%

The increase in oil prices since May 2003 and November 2006 have been enormous.  Some argue that the increase in the value of the Euro vs the U.S. dollar has had a significant impact on the increase in the price of oil.  The data above refutes that assertion.

What is the increase in oil prices costing Americans?

The USA consumes about 7.5 billion barrels of oil each year. Therefore, Americans are annually paying a lot more for oil as this chart demonstrates:  

                                Price     Change   Billions/Bbls   Cost $B

• May 2003     $22.00                        
• Nov. 2006     $59.00     $37.00  x         7.5          $277.5 
  
• July 2008    $145.00     $86.00  x         7.5          $645.0
  
• Total Change             $123.00  x         7.5          $922.5
  

This dramatic increase in the price of oil has become a huge drag on the U.S. economy because of all the reasons listed above.  To put the total cost increase impact in perspective, the Pentagon budget for 2007 was about $620 billion. It is interesting to note that the increase in oil costs dwarfs the $125 billion annual cost of staying in Iraq to defend our access to Middle East oil.

Why Have Oil Prices Risen So Much So Fast?

Oil prices rise and fall around the following key factors:

• The global demand for oil
• The global supply of oil
• Political risk
• Investor Demand/Hype
• Political decisions
  

Let's examine each factor:

• Demand
  

Global economic growth has accelerated significantly since May 2003.  The USA and the EU economies have performed well as have China's and India's.  Therefore, the demand for oil has risen.  However, global economic growth has eased significantly since November 2006 and this has relieved growth pressure on global oil supply.

• Supply
  

World oil production has continued to grow to exceed the demand growth.  There have been no supply shortfalls and the margin between supply and demand has not moved significantly. Iraqi daily oil production  currently approximates the differential by which global supply exceeds global demand.  Therefore, any significant interruption of Iraqi oil exports could create a supply crisis.

• Political Risk
  

• There was almost no political risk premium in the price of oil in May 2003 because the USA had just asserted its military dominance in the Middle East by taking down Saddam, and thereby strongly demonstrating its willingness to defend its interests in the region. 
  
• Since that time, there has been a steady erosion in the American voter's commitment to Iraq.  This is reflected in polls that show almost 60% of voters wanting America out of Iraq within one year without apparent regard for the economic consequences.
  
• In response to voter attitudes on Iraq, and as part of a political power strategy, the Democrat Party strongly advocates an early withdrawal of U.S. ground forces from Iraq without offering a credible security plan to deal with the chaos that would follow in Iraq, and the potential that it could ultimately threaten the other Middle East regimes. 
  
• As a result of the deterioration of political resolve on Iraq, the risk of an interruption in the supply of oil from Iraq and possibly the greater Middle East has continued to grow.
• The increased risk of a supply disruption in Iraq and perhaps beyond has contributed to dramatic increases in the political risk premium embedded in the price of oil.  If the Democrats take full power and execute their plan for an early withdrawal of U.S. ground forces from Iraq, the political risk premium in the price of oil will certainly increase as the fear moves toward reality.
  

• Investor/Hedger Demand/Hype
  

The Political Risk factors driving the radical increase in the price of oil since 2003 have attracted a large volume of speculative investors seeking to profit from the growing potential for higher oil prices and/or to hedge against that possibility as it might adversely affect their other interests.  The additional demand they create for oil based financial instruments has contributed to the rise in oil prices. 

If a major supply disruption were to appear imminent or actually occur in Iraq or if chaos should accelerate in the Middle East, oil would become an even greater investor safe haven/investment, and the demand they create could serve as a strong impetus to even higher oil prices.

• Political Decisions

After the 1973 oil embargo, Europe made the decision to aggressively pursue nuclear power and huge investments in electric driven public transportation.  Gerald Ford proposed the same approach in the USA, but the Democrat Congress killed the idea.   As a result of these political decisions, Europe is much less affected by the current oil price spike, and the American economy has become dangerously more dependent on foreign oil.  In 1975, America imported about on third of its oil consumption.  Today it is over 60%. 

America's huge oil and oil import dependence results in a much more destructive economic effect when oil prices spike.  It will take at least a generation to materially reduce America's oil dependence even if Democrats were not continuing to block all credible means to create new oil, nuclear and coal fired energy supply that would drive down USA oil demand and global energy prices.  As it stands now, whatever oil demand reductions are achieved by conservation are being more than offset by increasing demand in China, Inadia and elsewhere.  Therefore, USA conservation and minor "green" energy alternatives will not materially reduce the 13 million barrels per day that the USA imports every day, especially if the economy return to significant growth.   This means that huge new sources of energy supply are needed to avoid huge further oil price increases and their devastating economic effects.

The Geo-Strategic Effect of Higher Oil Prices

Over 60% of the increased costs shown above has been going into the coffers of oil exporters who are also enjoying the higher oil prices being paid by the rest of the world's oil importers.  These massive increases in cash inflows from higher oil prices have fueled the increase in belligerency from Russia and Iran as well as providing additional funds for Al Qaeda's financial sponsors to invest in their terrorist activities.

In Iran's case,  it means they have more money to finance Shiite militias in Iraq that are killing American soldiers as well as accelerate their quest to build their military and develop nuclear weapons that could enable them to further intimidate their Israeli and Arab Gulf State adversaries.  In spite of the huge increases in oil prices, Iran is experiencing  significant economic problems.  Were it not for the huge oil price increases, the Iranian regime might have fallen by now.

The Myths of the Oil Exporter Viewpoint

The advocates of a withdrawal from Iraq want us to believe that chaos in Iraq would not follow the USA's exit, and would not affect oil prices.  This premise rests on the misguided belief that it would still be in the exporter's self-interest to sell oil to the USA at a price that does not wreck the global economy, and thereby reduce the demand for oil.  This myopic viewpoint ignores the following realities:

• Oil is a finite asset, and a depleting resource for an exporter for as long as production continues.  Their objective is not to increase their near term revenues by increasing production, but to maximize the total value they receive for their oil reserves over its production life.
• From a macro perspective, total oil revenue for the reserves can be maximized by limiting the production rate and forcing up the price.
• Too high a price can create demand destruction, and put downward pressure on the price, but total  long term revenue can still be maximized by lowering the rate of production.
  
• The current Arab Gulf State regimes are the swing producers for global oil and they have been increasing oil production to match demand growth in exchange for America's military defense of their interests.  They are not generally hostile to America, but they have enjoyed the huge rise oil prices which is largely unrelated to supply/demand factors. 
  
• All of the major oil exporters rely almost exclusively on oil and natural gas revenues to sustain their economies.  None of them are significant exporters of anything else, and their economies would crumble if oil returned to $22 per barrel.
• The Arab Gulf State regimes are largely run by small royal cliques that do not share the wealth with their people as they should.  The regimes are militarily weak and often unpopular with the mass of their citizens.  Perhaps a majority of Saudis subscribe to radical Wahabism and oppose the current regime.
  
• The Arab Gulf State regimes are vulnerable to intimidation and/or attacks from radical Islamist elements that aspire to depose them.  This would likely intensify if the USA ground forces leave Iraq.
  
• An America withdrawal from Iraq would position Al Qaeda and/or Iran on the Saudi/Kuwait borders, and could represent a breach of faith on America's defense commitment to the Arab regimes.  This could force them into a choice between entering anti-American accommodations with Al Qaeda and/or Iran or to fleeing the region.
• Direct or indirect control of the Arab Gulf State reserves by radical Islamists would end accommodation with the USA and America's worst enemies could control almost 80% of the earth's oil reserves.  With that control, it would be in their zealous self-interest to limit supply, force up prices and increase their power at America's expense.

The "Big Oil" Myths

Rather than reconsidering the disastrous effects of their Iraq retreat policy on oil prices, the Democrats conveniently blame the huge increase in oil prices on price gouging by "Big Oil", and they clamor for higher taxes on "Big Oil" to redress this unfairness.  Please consider the following realities about the taxes paid by USA "Big Oil":

• $Billions
  Exxon Mobil               2004          2007          Change
  
  Total taxes paid          $57            $102          +$50
  Net Income                  $25            $  41          +$16
  
  This chart demonstrates that 75% of Exxon's increase in pretax income from 2004 to 2007 went to pay federal, state and local taxes rather than to Exxon shareholders. Therefore, governments have been the largest beneficiaries of the increase in oil prices since 2004, and these additional taxes represent a huge indirect tax increase on American consumers that no one is talking about.
  
  These hidden additional taxes are a drag on economic growth, but the bigger problem is that over 50% of the increase in oil costs has been going to foreign exporters of oil that cannot be taxed by the USA. Often the beneficiaries of these additional dollars are exporters like Iran, Russia and Venezuela who are America's greatest global adversaries.
  
  Every dollar Exxon pays in taxes is a dollar that is unavailable to find more oil or develop new energy resources.  Democrats understand all of this, but they love the benefits of hidden indirect tax increases that they do not have to defend to their voters.  The fact that the higher oil cost burden falls disproportionately on low income Democrat voters is acceptable collateral damage because they know their voters will never figure it out.
  

• The second big myth about USA "Big Oil" is that these firms have restricted their oil development and production rates to drive up the price of oil.  Please consider the following facts about USA "Big Oil" that refute this assertion: 

                                                                            12/31/07
                                                                          Proved Oil
              Billions of Barrels                                Reserves

              Exxon Mobil                                                 7.7
              Chevron Texaco                                           7.1 
              Conoco Phillips                                             3.1
                 Total USA "Big Oil" Reserves               17.9   
                 Total Global Oil Reserves                  1,182.0  
                  USA "Big Oil" as % Global Total          1.5%
 
The price of oil is determined on the global market.  The chart above demonstrates that USA "Big Oil's" reserves are not large enough to have a material effect on the price of oil.

The truth is that oil prices have risen dramatically because of the increasing threat to global oil supply in Iraq and the greater Middle East that is created by the Democrat's demands for a reckless abandonment of Iraq to chaos that could end Iraqi exports, and threaten global access to Middle East oil.  This problem is exacerbated by the Democrat's determined refusal to aggressively support nuclear and clean coal plant construction as well as oil drilling in ANWR and offshore USA. 

Blaming higher oil prices on "Big Oil" is just convenient demagoguery that furthers the Democrat's self-serving political ambitions at the expense of American consumers.   

     
Summary Comments & Solutions

Educated and reasonable people could argue about the reasons for the high price of oil today.  What is indisputable is that the oil price has risen radically since May 2003, and October 2006 and it cannot be explained by significant changes in the demand/supply balance or currency exchange movements.  It can be explained by the changes it the political risk and investment profile.

Everyone is talking about the $125 billion per year that the USA is spending in Iraq, but no one is adequately describing:

• The economic reasons for that continuing investment in relation to the additional almost $750 billion per year we are paying for oil largely as a result of our lack of political resolve on Iraq or
  
• the radical increase that would occur in that amount if we abandon Iraq and possibly the whole Middle East to chaos or
• the direct negative effect it would have on every voter's financial well being.
  

Nobody is talking about the underlying reasons for the dramatic increase in the price of oil or quantifying the dollar magnitude of that increase or discussing the devastating impact on the economy or offering serious ideas for reducing oil prices.  I would offer the following solutions that should have the effect of significantly reducing the price of oil and thereby relieving the stress on the economy.

• Eradicate the stigma attached to oil and the myths of energy independence by educating American voters about the perspectives represented in this analysis, and the very negative effect of a withdrawal from Iraq on oil prices, the economy and their personal financial well being.  This should cause the poll numbers to shift in favor of staying in Iraq for as long as it takes to defend our vital strategic interests. 
  
• Educate Americans that oil prices would only have to rise by $17 per barrel on average to offset the $125 billion the USA is investing in Iraq each year. Oil prices will rise by many multiples of $17 if the USA abandons Iraq to chaos, so it is much more cost effective to stay in Iraq than to leave.
• Educate Americans that Iraq is only costing 75% of Americans $5.00 per person per month which is a small investment in insurance against higher oil prices and the economic devastation that could occur if the USA abandons Iraq.
  
• Congress should pass a resolution with a strong majority that unequivocally states that America will remain in Iraq to help that nation recover, to defeat our terrorist enemies and to defend our vital economic interests no matter how long it takes.
• Congress should invest $50 billion per year in helping Iraq rapidly increase its oil production from 2.5 million barrels per day to their 8 to 10 million barrels per day potential. At $125 per barrel, America is spending $500 billion more for oil each year than they were when they elected a Democrat Congress that began demanding a retreat from Iraq. Therefore, $50 billion per year that could significantly increase global oil supply would be a great investment for American oil consumers.  Oil prices would only have to fall by $7 per barrel on average to recoup the $50 billion, and oil prices would fall by many multiples of $7 if the Iraqis reach their oil production potential.
  
• Congress should dramatically increase the incentives to rapidly build new nuclear and clean coal fired power plants and to incent a shift to electric fueled transportation.
  
• Congress should remove drilling restrictions in ANWR, offshore USA, and the western oil shales with stringent environmental requirements.
  
• Congress should incent consumers to decrease their energy consumption by 20%. 
  
• Congress should adequately fund initiatives to create viable new energy sources.
  

All of the above measures would:

• Send a strong message of resolve to the oil markets that should drive down the price of oil and trigger an economic boom.
  
• Encourage speculative financial investors and hedgers to leave the oil markets in large numbers.