On the face of it, OPEC’s decision to take 1.2 million barrels per day offline would seem like bad news for Americans enjoying today’s less exorbitant gas prices. Less supply equals higher prices.
Well the economics are neither as simple or intuitive as that. I interviewed oil economist Jim Williams of WTRG Economics and he made the case that by adding spare crude back into an oil market that’s been stretched to nearly maximum capacity, OPEC’s move may actually help lower gas prices.
“We’ve been running at 98 percent capacity,” says Williams, citing an oil market that’s seen its wiggle room narrowed dramatically by diminished production in Hugo Chavez’ Venezuela and by the halting and unreliable supply from Iraq. “You can’t even hiccup with that.”
The lack of spare capacity in the system has created a “security premium” — recently as high as $20 a barrel — that the markets have built in as a hedge against, say, Iran’s oil suddenly going offline or another hurricane in the Gulf. “There’s a tremendous premium built in in case something bad happens,” says Williams, “and a lot of bad things have been happening in the world oil markets over the past several years.”
Add spare capacity to the system as OPEC is doing, and yes supply goes down, but so does the sercurity premium. “With this much spare capacity,” says Williams, “Nigeria can blow up and we can cover it. A big chunk of the risk premium goes away” — and crude prices may start to settle back toward a figure governed by market fundamentals rather than jitters.
If this keeps up, says Williams, we may all be enjoying sub $2-a-gallon gas by next summer.