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The Wall Street Journal oped’s page idea of a “serious” policy on Iran …

August 22, 2005

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Is to keep Iran out of the World Cup (see Monday's Wall Street Journal).   

That is serious?

Moscow's boycott of the Los Angeles Olympics had such a profound impact on US policy ...

How about a serious effort to reduce US demand for oil instead?  The US is not going to end its dependence on imported oil.  There is too much oil that can be produced too cheaply outside the US, and US demand far exceeds any reasonable estimate of US supply.  But anything that cuts into US demand and lowers the market price of oil would certainly put a bit of pressure on Iran, a huge oil (and gas) exporter.  

I do not find the standard argument between the "peak oil" folks (summary - there is only so much oil in the ground that can be recovered, even oil prices rise further; increasing global oil production from current levels will be rather difficult) and "economists" (summary -- incentives matter, and higher prices will lead to increased supply and reduce demand) terribly useful.   It seems  to be largely the product of the different language used by geologists and economists.     

Talk about supply responding to higher prices irritates geologists, who note that there may only be so much oil ("supply") out there.  Their definition of supply is the amount of oil in the ground that geologists can find, combined with rate of production from those fields that maximizes the field's output over time (note that the production profile than maximizes total field output may be a bit different that production profile that maximizes profits).  No matter what the price, oil production in the continental USA is not going to rise to its 1970 level. 

At the same time, talk about demand outstripping supply always irritates economists, since at some price, demand always matches supply.  If prices rise, demand falls and production increases.  That is the core lesson of economics.  Markets find an equilibrium where supply equals demand. 

But that doesn't make the argument about the availability of supply irrelevant to economists.   We should care whether the equilibrium market price of oil is $20, $40, $60, $80, $100 - or far higher.   If supplies are rather constrained, that increases the pressure on prices.   And if the price has to rise to a very high level to choke off petroleum demand growth - whether by choking off economic growth or by encouraging conservation and substitution - oil consuming nations will be left rather worse off than they are now, let alone a few years ago.

The debate about demand outstripping supply is shorthand, at least to me, for a debate that matters, both politically and economically -- at what price will supply match demand?  

The availability of "supply" matters.   And so too does the "demand" response to higher prices.  So far, the demand response has been pretty minimal, in part because the US policy response has been pretty minimal.

Richard Berner of Morgan Stanley notes:

But here's the rub: So far, the rise in energy costs apparently has not significantly dimmed the pace of US or global economic activity.  Warnings that $50 oil and then $60 oil would threaten a global downturn have turned out to be too pessimistic.  Perhaps as a consequence, both investors and policymakers seem only mildly concerned that today's or even somewhat higher energy prices will be a threat.  

That is a combination that favors the interests of oil producers.

Some oil producers are US allies.  But many are not. 

Some are democracies.  But many are not.

Read Zakaria.

Update.  Yglesias makes an interesting point.  The more energy an oil exporter produces without burning fossil fuels, the more fossil fuel it can export.  With Iran selling its "fossil fuel" energy at ridiculously low prices inside Iran, that incentive is all the more powerful.   Not to say that Iran's nuclear program is totally peaceful.  I tend to agree with Takeyh.  Iran has pretty strong strategic incentives to want nukes (Pakistan next door, bloody war with Iraq in 80s, USA), though it might settle for what Takeyh calls "nuclear ambiguity" -- i.e. we could produce bombs, and know how to do it, but have opted not to for the time being ...    However, it is worth noting that those incentives overlap with the economic ones in a sense.  Domestic nuclear power = more oil and gas to export to China and India since less needs to be burned at home = more friends and leverage.

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