Oil prices remain high. Producers, small and large, feel the squeeze, as their costs continue to rise; as well as consumers, who ultimately are the ones to pay for these higher costs. Whats more important is that few expect any significant declines in the near future as the demand for oil continues to rise, especially in developing economies.
While some consumers and politicians in countries around the world are seeking to hold oil companies accountable for high prices, economists offer a simple explanation – demand and supply forces determine the price. In Russia, for example, gasoline is set to surpass the psychological barrier of 20 rubles per liter and many here once again are asking the question of how can oil be so expensive in a country that has so much of it? Talks of political control over companies are not uncommon here. Yet we all know that political measures to control prices can lead to devastating results – even higher prices and reduced access to oil.
Nonetheless, some countries continue to subsidize oil prices and the results of such actions are somewhat predictable. Iraq may not be the best of the examples, but, nonetheless, this year it has been facing one of the worst oil crises in its history. The government blamed fuel shortages in the country on insurgent attacks. This, however, is only part of the story. An Iraqi economist visiting CIPE several months ago, noted that government subsidies have pushed fuel out of the formal economy into black markets. In many cases, the fuel was simply smuggled across the border into the neighboring countries, so, as he put it, the Iraqi citizens were essentially subsidizing the cheap fuel in other countries. You can read the full article here.
In the end of the say, economists are right about demand and supply, and history can clearly prove their claims. But demand and supply, however, do not provide the full picture. Beyond the surface there are other components, and one of those components is called efficiency.
I was somewhat surprised to find out in this recent article in the Economist that nationally-owned oil companies manage nearly 90% of the world’s oil supplies. That means only 10% is in the hands of private sector firms. Only 10% of the oil supplies is in the hands of more efficient companies?! Or, in other words, 90% of the oil supplies is in the hands of companies most of which are simply not capable of selling that oil at lower price due to efficiency failures.
Wait, someone will say, but there are instances when the state-oil companies charge a lower price at the pump. This may be true, but what is also true is that these lower prices are subsidized by the government, which means that citizens are the ones paying for it, although not directly when purchasing it.
In all, as the Economist article notes
Few of the princes, politicians and strongmen who wield ultimate authority over these firms can resist the urge to meddle. At best, that leads to the sort of inefficiencies found at most state-owned firms: overstaffing, underinvestment and so on. At worst, the business of pumping and selling oil is entirely subsumed by politics, as in the case of Petróleos de Venezuela, one of the biggest NOCs (see article). In either case, NOCs produce less oil, more expensively, than they should.
The solution? Privatize state-owned companies to make them more efficient and less prone to political, rather than economic, decision-making. Or, at least, introduce some corporate governance mechanisms. But I am sure it is easier said than done.
Published Date: August 29, 2006