Political instability in the Middle East over the past month has driven parallel unrest in world oil prices. The drive for political freedom in the Middle East has rightfully captured the world’s attention, but it has also roiled oil markets. Governments across the globe are worried that sustained unrest will escalate oil prices past $100 per barrel on their way to $120 or more, choking the struggling economic recovery in the United States, Europe, and elsewhere. One entity, however, is almost certain to benefit from this volatility: Big Oil companies.
On Friday, Jan. 28, oil closed at $89 a barrel — $4, or 5 percent, higher than the previous day. This leap reflected concerns that the Egyptian revolution would interfere with Persian Gulf oil transportation and deliveries. Prices returned to $85 a barrel when President Hosni Mubarak resigned on Feb. 11, reflecting some stability.
While Egypt generates relatively little oil, Libya is an important producer, yielding 1.8 million barrels [PDF] daily, or 2.1 percent of worldwide production [PDF]. It is a vital oil supplier of sweet, light crude to Europe. Although the United States imports almost no Libyan oil, prices are set on a world market. So it affected the U.S. gasoline prices when the more violent unrest in Libya boosted oil prices to $98 per barrel — a $12, or 14 percent leap — in a week. As foreign oil workers flee and unrest continues, a Libyan supply disruption — and further price hikes — could follow. Simmering unrest in Bahrain, which produces 48,000 barrels per day, could increase prices further.
The lingering effects of the recent global recession amplify the impact of rising oil prices, since higher fuel prices affect the bottom line for families and businesses. In the past year, families have experienced a 13 percent and 17 percent increase in gasoline and fuel heating oil prices, respectively. Meanwhile, family incomes have stagnated.
High Frequency Economics notes that, “Higher crude oil prices affect the economies of oil-importing nations like a tax increase … transferring purchasing power from consumers of energy to producers.” This could exacerbate economic problems in struggling nations such as Portugal, Ireland, Greece, and Spain.
The New York Times warned that in the United States:
A sustained $10 increase in oil prices would shave about two-tenths of a percentage point off economic growth, according to Dean Maki, chief United States economist at Barclays Capital. [He] estimates [the] increase would offset nearly a quarter of the $120 billion payroll tax cut that Congress had intended to stimulate the economy this year.
The Times also notes that higher oil prices would lead to lower consumer spending. This could smother the nascent economic recovery. Higher oil prices could also hike food prices.
A cutback in consumer spending reverberates through the economy by crimping businesses, making it less likely that employers will commit to the additional hiring needed to lower the 9 percent unemployment rate.
The rise in oil prices could also create a vicious cycle, as higher energy costs propel already rising food prices, which in turn can lead to more political unrest and more global uncertainty.
Americans sent nearly $1 billion a day overseas to pay for oil in 2010. These purchases make up nearly half of our trade deficit [PDF]. And every dollar that leaves the country to buy a barrel of oil leaves the domestic economy never to return as investment to create jobs or growth.
While higher oil prices are bad news for the economy and families, oil price increases over the past decade have helped grow profits for the big five oil companies: BP, Chevron, ConocoPhillips, ExxonMobil, and Shell. It’s not a coincidence that these five oil companies set profit records in 2008, the same year that oil reached its all-time high of $147 per barrel. When oil prices crashed in 2009, so did profits. There is an exception. Even though prices rose last year, the costs of BP’s Deepwater Horizon disaster spilled red ink over its otherwise healthy balance sheet, lowering the big five companies’ total profits by $17 billion. Rising oil prices may be bad news for families but they are generally excellent news for Big Oil.
Turmoil in the Middle East does not impact the intrinsic value of crude oil. It has no effect on extraction technologies or labor intensiveness of oil production or refinement. These costs are relatively fixed. So as prices are driven higher by fears of future supply disruptions or shortages, the oil the companies have is worth more, and profits rise too. This tandem price-profit rise is characteristic of the oil industry, as the chart above demonstrates.
Given the large profits for Big Oil, retaining tax loopholes for these companies while cutting vital federal investments makes no fiscal sense. The unnecessary loopholes provide nearly $4 billion annually to the oil industry, funds that President Obama now proposes to invest in clean energy programs.
For instance, oil companies can exploit the tax break designed to keep domestic manufacturers on shore. Former CAP Senior Policy Analyst Sima Gandhi described the absurdity of extending this special tax break to Big Oil and gas companies since they cannot move an onshore or offshore oil field to another nation.
Companies that manufacture, produce, or extract oil and gas or any primary derivative receive a manufacturing subsidy provided that the product was made in the United States. But since removing this subsidy does not affect the production of oil [in the United States], the subsidy does not significantly affect business decisions.
Big Oil companies could also benefit from as much as $53 billion in unpaid royalties from their production of oil from federal waters — oil owned by American taxpayers. Rep. Ed Markey (D-Mass.), ranking Democrat on the House Natural Resources Committee, attempted to halt this huge taxpayer rip-off by offering an amendment to the House Republicans’ fiscal year 2011 budget.
The amendment to the Republicans’ spending bill would have fixed a flaw put in place by a Republican-controlled Congress in 1995 and seek to recover funds from faulty drilling leases in the Gulf of Mexico that allow oil companies to drill without paying any royalties. The Government Accountability Office (GAO) has estimated that taxpayers could lose up to an additional $53 billion over the next 25 years as a result of royalty-free drilling when oil prices are high. The Interior Department also informed Rep. Markey that American taxpayers will lose $1.5 billion just this year from this free drilling.
Unfortunately, his amendment lost on a vote of 174-251. Only 11 Republican House members (5 percent of the caucus) voted to end this costly practice while 25 Democrats (13 percent of the caucus) voted to maintain these handouts.
Instability in nations with oil reserves threatens the production, transportation, and deliveries of oil. Since oil prices are set on the world market, such events affect the world oil price. Therefore, it matters very little that the United States imports minimal amounts of crude from Libya and Algeria and none at all from Iran. Unrest in these nations will raise prices and slacken our economic recovery. Meanwhile, higher prices will mean pain at the pump for families and higher profits for Big Oil companies.
Long-term measures are essential to dramatically reduce our dependence on oil. But some immediate steps would help reduce the pain at the pump. Given that Big Oil will likely profit from Americans’ misery at the pump, we should first end the tax loopholes and royalty relief granted to Big Oil companies to recoup some of these lost tax dollars. To minimize price shocks, President Obama should sell 30 million barrels of oil from our full emergency reserves and invest the $3 billion from sales into public transit such as buses and subways. These steps would cut federal spending, reduce prices, and reduce demand while Big Oil companies continue to make big profits.