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Tuesday, October 18, 2005

Alan Greenspan on Energy

Alan Greenspan discusses oil and energy in this speech given in Japan. The speech covers the days of John D. Rockefeller and Standard oil to the present day, and speculates into the future. He believes the recent rise in oil prices will slow the economy, but with the flexibility and adaptability that market systems provide, and the changes the economy has undergone in response to high oil prices in the past, the rise in oil prices should prove far less costly in terms of both output losses and higher inflation than in the 1970s. As always, he expresses his great faith in free markets as the best solution to economic problems:

Energy, by Alan Greenspan: Even before the devastating hurricanes of August and September 2005, world oil markets had been subject to a degree of strain not experienced for a generation. Increased demand and lagging additions to productive capacity had eliminated a significant amount of the slack in world oil markets ... Although the global economic expansion appears to have been on a reasonably firm path through the summer months, the recent surge in energy prices will undoubtedly be a drag from now on. In the United States, Japan, and elsewhere, the effect on growth would have been greater had oil not declined in importance as an input to world economic activity since the 1970s. How did we arrive at a state ... so fragile that weather, not to mention individual acts of sabotage or local insurrection, could have a significant impact on economic growth? ... The history of the world petroleum industry is one of a rapidly growing industry seeking the stable prices that have been seen by producers as essential to the expansion of the market. In the early twentieth century, pricing power was firmly in the hands of Americans, predominately John D. Rockefeller and Standard Oil. ...  Rockefeller had endeavored with some success to stabilize those prices by gaining control ... of nine-tenths of U.S. refining capacity. But even after the breakup of the Standard Oil monopoly in 1911, pricing power remained with the United States ... Indeed, as late as 1952, crude oil production in the United States ... still accounted for more than half of the world total. ... Of course, concentrated control in the hands of a few producers over any resource can pose potential problems. ...[T]hat historical role ended in 1971, when excess crude oil capacity in the United States was finally absorbed by rising world demand. At that point, the marginal pricing of oil ... abruptly shifted to a few large Middle East producers ... To capitalize on their newly acquired pricing power, many ... in the Middle East, nationalized their oil companies. But the full magnitude of the pricing power of the nationalized oil companies became evident only in the aftermath of the oil embargo of 1973. ...[and the] ...  further surge in oil prices that accompanied the Iranian Revolution in 1979... The higher prices of the 1970s abruptly ended the extraordinary growth of U.S. and world consumption of oil and the increased intensity of its use ... In the United States, between 1945 and 1973, consumption of petroleum products rose at a startling average annual rate of 4-1/2 percent, well in excess of growth of our real GDP. However, between 1973 and 2004, oil consumption grew ... at only 1/2 percent per year... Much of the decline in the ratio of oil use to real GDP in the United States has resulted from growth in the proportion of GDP composed of services, high-tech goods, and other presumably less oil-intensive industries. Additionally, part of the decline in this ratio is due to improved energy conservation ... These trends have been ongoing but have likely intensified of late with the sharp, recent increases in oil prices... [T]he story since 1973 has been as much about the power of markets as it has been about power over markets. ... The failure of oil prices to rise as projected in the late 1970s is a testament to the power of markets and the technologies they foster. Today, the average price of crude oil ... is still in real terms below the price peak of February 1981. Moreover, since oil use ... is only two-thirds as important an input into world GDP as it was three decades ago, the effect of the current surge in oil prices, though noticeable, is likely to prove significantly less consequential to economic growth and inflation than the surge in the 1970s...

[T]he opportunities for profitable exploration and development in the industrial economies are dwindling, and the international oil companies are currently largely prohibited, restricted, or face considerable political risk in investing in OPEC and other developing countries. In such a highly profitable market..., one would have expected a far greater surge of oil investments. ... But because of the geographic concentration of proved reserves, much of the investment in crude oil productive capacity required to meet demand, without prices rising unduly, will need to be undertaken by national oil companies in OPEC and other developing economies. Although investment is rising, ... many governments perceive that the benefits of investing in additional capacity to meet rising world oil demand are limited. ... Unless those policies, political institutions, and attitudes change, it is difficult to envision adequate reinvestment into the oil facilities of these economies. Besides feared shortfalls in crude oil capacity, the status of world refining capacity has become worrisome as well. ... A continuation of this trend would soon make lack of refining capacity the binding constraint on growth in oil use. This may already be happening in certain grades... [T]he expansion and the modernization of world refineries are lagging. For example, no new refinery has been built in the United States since 1976. ... Much will depend on the response of demand to price over the longer run. If history is any guide, should higher prices persist, energy use over time will continue to decline relative to GDP. ... With real energy prices again on the rise, more-rapid decreases in the intensity of energy use in the years ahead seem virtually inevitable. Long-term demand elasticities over the past three decades have proved noticeably higher than those evident in the short term...

Altering the magnitude and manner of energy consumption will significantly affect the path of the global economy over the long term. ... We cannot judge with certainty how technological possibilities will play out in the future, but we can say with some assurance that developments in energy markets will remain central in determining the longer-run health of our nations' economies. The experience of the past fifty years ... affirms that market forces play a key role in conserving scarce energy resources, directing those resources to their most highly valued uses. However, the availability of adequate productive capacity will also be driven by nonmarket influences and by other policy considerations. To be sure, energy issues present policymakers with difficult tradeoffs to consider. The concentration of oil reserves in politically volatile areas of the world is an ongoing concern. But ...one hopes ... that ... does not distort or stifle the meaningful functioning of our markets. Barring political impediments to the operation of markets, the same price signals that are so critical for balancing energy supply and demand in the short run also signal profit opportunities for long-term supply expansion. Moreover, they stimulate the research and development that will unlock new approaches to energy production and use that we can now only barely envision. Improving technology and ongoing shifts in the structure of economic activity are reducing the energy intensity of industrial countries ... If history is any guide, oil will eventually be overtaken by less-costly alternatives well before conventional oil reserves run out. Indeed, oil displaced coal despite still vast untapped reserves of coal, and coal displaced wood ... New technologies to more fully exploit existing conventional oil reserves will emerge in the years ahead. ... We will begin the transition to the next major sources of energy, perhaps before midcentury, as production from conventional oil reservoirs ... is projected to peak. In fact, the development and application of new sources of energy, especially nonconventional sources of oil, is already in train. Nonetheless, the transition will take time. We, and the rest of the world, doubtless will have to live with the geopolitical and other uncertainties of the oil markets for some time to come.

    Posted by on Tuesday, October 18, 2005 at 12:15 AM in Economics, Fed Speeches, Oil | Permalink  TrackBack (0)  Comments (4)


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