Socialism Not Speculation to Blame for High Oil Prices

More than 75% of the world’s oil reserves are controlled by national oil companies. Of the world’s top 20 oil-producing firms, 14 are state-run. Those areas where private companies have been able to drill have recently been shrinking, and remaining private companies are facing hostile governments that may try to nationalize them.

Meanwhile, Congress, pandering to the least economically sound sentiments of the American public, recently tried to pass a bill to curb oil market speculation. This, lawmakers argued, was the way to get prices down. Speculation is just trading on the future price of a good. There have been many reasons to expect the price of oil to continue to rise. Along with rising demand, and subsidies to aid the rise in demand, there is a lot of risk. Risk causes volatility and drives prices up — at least in the short term.

There is risk because of the war in Iraq, because of the government in Iran, terrorism, and then there is additional risk because of the growing number of countries where the governments are trying to nationalize the oil supply.

This typically starts with the government harassing private oil companies. Clearly that makes owning stocks in those companies risky as owners will lose their investment. This can also fuel volatility in the futures markets as investors try to predict the likelihood of nationalization. If those companies get taken over or forced out, the total supply of oil may fall and so the future price will be higher.

This has been going on for a few years now. And the trend continues to worsen. Russia’s Vladimir Putin jailed the ex-chief of Yukos oil company so that it could be taken over by state-owned Rosneft in 2004. And today in Moscow, British Petrol is being hassled and taken to court.

In 2003 Hugo Chavez took the reigns of Petroleos de Venezuela in a “re-nationalization” move, and now Ecuador is taking Chevron to court. This little move by Ecuador could be the start of something bigger, as it looks like Ecuador might join forces with Chavez’s state-run venture, which might in turn join forces with Russia’s.

Bolivia also nationalized in 2006. Soon there will be nowhere left outside of Western Europe and the U.S. where private oil can safely drill.

Another reason that nationalization can drive prices up is that state-owned companies tend to under-produce private ones, creating additional risk that long-term output will be lower. Finally, consolidation of oil companies into just a few nationalized firms, especially when those countries form cartels rather than competing freely on the market, will also drive up prices. This trend in nationalization is simply an extension of the existing problems of OPEC. It should be obvious that this trend is contributing to the high oil prices.

But rather than see the reasons for the rise in prices — the real risks which face the oil market — Congress tries to strangle speculation, prevent new drilling, and it even flirts with idea of nationalizing our own supply. Reps. Maurice Hinchey (D-N.Y.) and Maxine Waters (D-Calif.) both recently suggested it, and a recent poll shows many Democrats(and even a few Republicans) think it’s a good idea. But nationalizing is the problem, not the answer.

cross-posted at Heritage.

Rent-Seeking and The Housing Crisis

Recently, a scandal has broken out that provides great insight into the housing crisis. Countrywide Mortgage brokers have been treating Congress to VIP lending rates. Accepting donations of $100 or more is illegal for these politicians, but scandals like this are not uncommon. The deeper question is why a profit-seeking business like Countrywide would want to offer discount rates to government officials in the first place. It is, of course, because they expect something in return.

If government could not offer these businesses any preferential legislation, exemptions from taxes or relief from anti-business regulations, there would be no incentive to buy them off.

Economists call this kind of activity rent-seeking. When firms spend money – or decrease their profit – in order to ensure favorable treatment by government it is not efficient. They produce no more output, and instead the resources are wasted. The favorable treatment gives them a monopoly position or an advantage over their competitors and the consumer suffers.

It also encourages government officials to pass more kinds of regulations that strangle business so that there are more chances to offer relief in exchange for pay-offs from the businesses. So, it creates a feedback loop leading to more regulations, more bribes and then even more regulation.

The only way to end the cycle is to limit the scope of government with a clear line preventing government from offering any kind of preferential treatment to firms.

But rather than moving toward a smaller scope of government, we are currently headed in the opposite direction. The new housing bill is set to bail out firms on a preferential basis – often by helping those, like Countrywide, who made the most risky sub-prime loans. In the future, these businesses will remember the compassion of Congress and will take these risks again.

Local governments will benefit too – with $3.9 billion in community development block grants. These grants are provided so that local governments can purchase, renovate and resell foreclosed homes. The proceeds can then be used to do this again next time that government subsidies followed by government bailouts lead to a new round of foreclosures. In this way, government can cause a crisis, solve it, and cause a new one, little by little expanding its scope in the process.

Have we not learned the lessons of the National Recovery Administration, when subsidies and bailouts, public works programs, and stringent regulations led us to a consolidation of government and big business that strangled private initiative and threatened the liberties we hold dear? Apparently we have not – a recent Time Magazine poll showed that 82% favor public works projects and 70% say more government programs are needed for those struggling.

The more that we allow government to solve our economic woes, the more that it expands its scope and creates new woes, just to have something more to solve. This is the rent-seeking power of government at its most frightening.

Cross-posted at the Heritage blog.

Note that the Center for American Progress was very enthusiastic about the community development block grants - HT Econlog for that.