Legal Commentary

Why We Should Be Rooting for $200 per Barrel of Oil--Posner

By Richard Posner

As Becker explains, we cannot predict the future price of oil. But it is unlikely to rise in the foreseeable future to $200 a barrel, especially if we think in inflation-adjusted terms. Oil prices in real terms have fluctuated a great deal. In December 2007 dollars the price of oil was below $20 in 1946, above $100 in 1979, and only about $10 a recently as 1998. High prices affect both demand and supply; the recent price peaks have already reduced demand for gasoline in the United States and increased efforts to discover and exploit new oil fields. The United States has large untapped oil reserves both offshore and in Alaska, and there are many other untapped reserves elsewhere in the world. Supply is responding to the high price of oil and will respond more. If Iraq ever stabilizes, its output of oil will increase. Were the world price of oil to rise to a level close to $200, both demand and (with a lag) supply would respond. Oil trapped in sand and shale--a potentially very large supply--would become economical. In the longer run, very high oil prices will further stimulate the development of alternative fuels.

Major political or natural catastrophes could of course alter the picture. Middle eastern oil supplies are vulnerable to the ever-present threat of war in that region, and the oil industries of Venezuela, Nigeria, and possibly even Saudi Arabia are vulnerable to political unrest, civil war, or terrorism.

I would like to see the price of oil rise to $200, despite the worldwide recession that would probably result, provided that it rises as a result of heavy taxes on oil or (better) carbon emissions. The taxes would jump start the development of clean fuels, and the financial impact on consumers could be buffered by returning a portion of the tax revenues in the form of income tax credits. That would not reduce the effect of the taxes on the demand for oil or the incentives to develop alternative fuels, because the marginal cost (the production and distribution cost plus the tax) of oil to consumers would not be affected. Higher oil prices are necessary to check global warming, reduce traffic congestion, and reduce dependence on foreign oil, so much of which is produced by countries that are either unstable or hostile to the United States. Heavy taxes on oil would reduce not only the amount of oil we import but also the revenue per barrel of the oil exporting nations, so there would be a double negative effect on those countries' oil revenues: they would sell less oil and earn less per unit sold. The reason for the latter effect is the upward-sloping supply curve for oil. Suppose the first million barrels of oil can be produced at a cost of $1 per barrel and the second million at $2 per barrel. If total demand is one million barrels, the suppliers break even: they have revenues of $1 million and costs of $1 million. If total demand is two million barrels, the suppliers have revenues of $4 million (because the price of all barrels is determined by the price that the marginal purchaser is willing to pay) but costs of only $3 million ($1 million for the first million barrels, $2 million of the second). The lower the price of oil received by the oil producers (that is, the price net of tax), the lower their net income.

Unfortunately I cannot see a confluence of political forces that would make heavy taxes on oil feasible. We seem to be experiencing a democratic failure, in which long-term problems simply cannot be addressed.

Full post as published by Becker-Posner Blog on May 11, 2008 (boomark / email).