The U.S. Can't Control the World Oil Market

About Severin Borenstein:

Severin Borenstein is E.T. Grether Professor of Business Economics and Public Policy at U.C. Berkeley's Haas School of Business and co-director of the Energy Institute at Haas. He teaches course in microeconomics and energy markets and has published numerous papers on oil and gasoline markets.

Oil prices drive gasoline prices and current oil prices are high. But $125 per barrel oil today is no more the fault of President Obama than $147 oil was President Bush's fault in June 2008. There is very little the U.S. president can do to change oil prices over months or a few years. U.S. oil production was up 13 percent in 2011 over 2008, but still remains less than one-tenth of the world oil market.

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Producing more oil domestically will enrich the U.S. economy, particularly U.S. oil companies and their workers. With oil so valuable, it may be a good idea, though the value must be weighed against environmental consequences. But it will have no discernible impact on gas prices, because it will change the world's supply/demand balance for oil by less than 2 or 3 percent over a decade or more.

In fact, the impact on gas prices would probably be about the same as the recent increase in U.S. fuel economy standards will have over the next 20 years: somewhere between very little and none. The advantage of doubling fuel economy is that it will halve the cost of driving even if it has no impact on gas prices.

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Many on the left, and a few on the right, argue that misguided or nefarious speculation in oil futures markets has driven oil prices well above their true competitive level. The claim, however, is rejected by nearly all economists across a broad range of political perspectives, from Paul Krugman to the Heritage Foundation. Speculation can cause short-run increases in oil price—on the order of days or weeks—but eventually if the price doesn't equate real physical demand with real physical supply, a massive buildup of inventories puts downward pressure on prices.

So what does drive the price of oil and therefore gasoline? The real physical suppliers do, especially Saudi Arabia. The Saudis hold more spare capacity today than the U.S. could bring online in the next decade even if all federal lands were opened to drilling. Likewise, the factors that drive the physical demand for oil, particularly the growing demand from China, India, and other developing countries, push up U.S. gas prices.

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Those factors aren't going to change anytime soon. Even with the new drilling technologies, most oil production and the vast majority of reserves will remain in the Middle East and Africa. And the growth of oil demand from the developing world is much more likely to accelerate than abate. We need to adapt to this changing world, hoping that new supplies keep prices under control, but preparing for a world with permanently higher gasoline prices. Nothing the politicians are going to say or do will change those hard realities.

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