I’m planning to write more about what Bob McNally and I have to say in our new article in Foreign Affairs. I’m going to start, though, with a response from both of us to some misunderstandings in Steve LeVine’s post on the article over at ForeignPolicy.com.
“Robert McNally and Michael Levi try to plumb the mysteries of oil prices (temporary access to the subscription-only site). They do not get far -- their anti-climactic top-line conclusion is that oil prices are volatile, and will remain so, a deduction that every person on Earth with a driver’s license no doubt made quite some time ago.”
Really? Had you polled drivers a year ago, what fraction would have predicted that four dollar a gallon gasoline was possible by this spring? Everyone now thinks crude price gyrations up to the mid-$100 range and down to the low $30s within a few years are the new normal? LeVine may have figured it out years ago, but we don’t think all the world’s motorists, macro policy officials, airline executives, and investors - not to mention traders - have gotten that memo just yet.
LeVine continues with an argument that might explain why he’s confused:
“McNally and Levi assert that the ‘economic and national security implications are stark,’ but surely they do not mean as a result of volatility: Volatile low oil prices, say in the $50-$60 a barrel range, are not economic or security threats, at least to consuming nations. So one presumes that, without actually saying so, McNally and Levi actually are predicting relatively high and volatile prices.”
We suspect that when LeVine writes that our conclusion is one “that every person on Earth with a driver’s license no doubt made quite some time ago”, he’s assuming that we’re talking about high prices – and indeed many Americans seem to be concluding that higher prices are here to stay. But that’s not what we’re saying. Yes, we note early on that average prices are going to be higher than they’ve been in the past, but we then emphasize that our essay is about something else: we’re talking about swinging prices, which are a different thing.
Let’s go a bit deeper. LeVine writes that we “surely… do not mean [that economic and security implications are] a result of volatility”. Actually, we do, as we explain at great length in the essay. Uncertain prices complicate (and tend to defer) investment by individuals and firms, and wreak havoc with monetary policy. These are distinct challenges that high or low prices alone don’t present. The fact that wild price swings result from low spare capacity, a point that’s core to our argument, also means that world economies are more sensitive to geopolitical unrest; hence the stark security implications. If prices were high or low but stable, these geopolitical issues wouldn’t matter.
LeVine also writes puzzlingly that “volatile low oil prices, say in the $50-$60 a barrel range, are not economic or security threats”. We can’t say we understand how it’s possible for oil prices to be both in the $50-$60 range and volatile at the same time – that’s a pretty narrow range.
LeVine’s post finishes thusly:
“Such a forecast [of high prices] would align McNally and Levi with Goldman Sachs and other pure commodities analysts, who do not foresee supply catching up to demand any time soon. On the other hand, a new report by James West at Barclays Capital reports that oil companies around the world are in an explosion of spending on exploration -- Big Oil as well as smaller, independent companies are on course to fork out more than half a trillion dollars on exploration this year ($529 billion to be precise), or 16 percent more than the $458 billion that they spent in 2010. These companies are so spending partly because of the above forecasts of high oil prices. Of course, if they produce too much, prices will again head down.”
Exactly. If prices head up (which Barclays, among others, still predicts) and then crash because of overinvestment in supply (which, to be honest, we suspect isn’t likely any time soon), that wouldn’t be a counterpoint to our analysis – it would be evidence for it. Big ups and downs are precisely what an era of swinging oil prices is all about.