Behind gas-price woes: US slowing of foreign drills

Who's to blame for the approximately $2 a gallon most Americans paid for gasoline on their Thanksgiving Day travels?

To quote Pogo, the key character in that old comic strip, "We have met the enemy and he is us."

Over the past 24 years, United States foreign policy has discouraged several oil-exporting nations from adding to their capacity to produce more oil, says A.F. Alhajji, an economist at Ohio Northern University in Ada. The result has been a decline in the excess capacity of OPEC as a group. This means there is less ability for oil producers to counter upward price pressures from the growing demand for petroleum from China and India, or from short-term problems, such as the bombing of pipelines in Iraq, hurricane damage to wells in the Gulf of Mexico, and political turmoil in Nigeria or other oil-exporting nations.

For various foreign-policy reasons, the US has imposed sanctions on Iran, Iraq, Sudan, Libya, and Burma (Myanmar). This step has prompted American and sometimes foreign oil companies to pull out of or stay away from these nations. Without foreign investment, the countries could not boost oil output capacity as much - a situation that still has a lingering effect on production.

Although proclaiming its neutrality in the 1980-88 war between Iran and Iraq, the US at times helped both sides militarily. Saudi Arabia, Kuwait, and some other Arab Middle East nations assisted Iraq financially during the war. As a result, they had less money to develop their oil fields. Saudi Arabia and Kuwait produce less oil today than they did in the 1970s. Iran's oil development stalled. The war "drained the financial resources of the whole area," Mr. Alhajji says.

Iran, which prior to its 1979 revolution produced 6 million barrels a day, pumps oil today at a rate of only 3.9 million b.p.d.

The latest damage to world capacity, perhaps temporary, resulted from the US invasion of Iraq. Iraq pumped 3.8 million b.p.d in 1979 before its war with Iran and 3 million b.p.d before the US moved into Baghdad last year. Nowadays, it produces between 2 million and 2.5 million b.p.d.

Alhajji, a Syrian-American, maintains this decline in excess world oil production capacity has resulted in a rise in prices from around $10 a barrel in 1999 to $35 in 2000 to between $49 and $55 today.

The higher prices could last. History indicates it takes at least three years for a nation's oil output to recover fully from a war or other severe disturbances, Alhajji says. He points to the wars in Iraq, Iran, and Kuwait over the past two decades, as well as the difficulty Russia faced in its transition to a market-based economy after the breakup of the Soviet Union. Because of the present situation in Iraq, Alhajji doubts that country can reach 5 million b.p.d by 2010, as some interim Iraqi leaders have claimed. The failure to boost Iraq oil production quickly means the US will face additional costs of reconstruction in Iraq.

One of the Bush administration's best postwar decisions, Alhajji says, was to invest $2.3 billion to rehabilitate the Iraqi oil sector and employ an overwhelming force of soldiers and private contractors to protect the oil facilities. That protection combined with higher oil prices has given Iraq a large windfall in revenues.

Another positive note for Iraq: Last week the world's leading industrial nations agreed to cancel 80 percent of the nearly $39 billion debt owed them by Iraq. But Iraq still owes Saudi Arabia and other Arab nations even more from the Iran-Iraq War - money that could have been used to raise their ability to produce more oil.

Today's higher oil prices, meanwhile, will seriously damage the world's economy, some economists predict. Higher prices in 2005 will cost the US 0.7 percent of gross domestic product, the Euro zone 1.1 percent, and Japan 0.9 percent, according to Philip Verleger Jr., an economist with the Institute for International Economics in Washington.

That's a sizable blow. In the past, sharp rises in oil prices were followed by recessions in the US, such as those in the 1970s, 1991, and 2001.

But it is different today, Alhajji argues. In the 1970s, US government expenditures were decreasing. Now, federal spending is increasing rapidly. Defense and security outlays are bigger. Monetary policy remains easy, despite recent small jumps in short-term interest rates.

Moreover, the depreciation of the dollar versus the euro and the yen means that the rising dollar price of oil is not a big burden for Europe or Japan.

Another factor is that real per capita income in the US has increased faster than oil prices. While Americans could buy with their annual income around 500 barrels of oil between 1974 and 1986, they can, on average, buy 800 barrels now.

Americans, Alhajji says, can therefore afford $2.50 a gallon for gasoline. Their higher incomes compensate for any negative effect of high oil prices. In constant prices, oil is cheaper today than the $60 a barrel in 1981, after the Iranian revolution.

As for the months ahead, Alhajji expects the fluctuation of oil prices to depend on whether the US and other oil importing nations face a hard or a mild winter. If it's tough, prices could rise even further, he says.