Telling the people what they want

There is always a lot of talk in the US about market-driven pricing. Americans pride themselves on taking an unflinching approach to capitalism.

There is always a lot of talk in the US about market-driven pricing. Americans pride themselves on taking an unflinching approach to capitalism. What is a cup of coffee worth? How much should one pay for a 24-pack of light beer? Let the market decide. Supply and demand will dictate what should be paid. Generally, when such an approach is being advocated by the man in the street, it is in response to a sudden increase in price of something purchased on a regular basis. Consumers are suspicious of price swings and invariably respond with accusations of price gouging or profiteering. Forgotten for the moment is the idea of supply and demand as consumers insist on price stability.

Of course, the two are all but mutually exclusive. Commodity prices that are based on supply and demand – meaning prices driven by the market conditions – are volatile. One of the ways to ensure that pricing is sound is to look at how it responds to changes in the market. If the response is sluggish, there is likely something wrong with the pricing structure.

The idea that stable prices are associated with market drivers is central to the public's misperception about energy costs. When there is a glut of oil flooding the market and gasoline prices drop to below $1/gal, consumers feel validated. The market has spoken and this is the result – cheap energy for the masses. But as these low prices spur increased consumption (demand), the temporary glut dries up, and the prices begin to rise. The consumption is, of course, slow to respond, so the prices continue rising until they surpass the optimal price. Eventually, this increase curbs demand, but not soon enough to avoid a temporary imbalance. Consumers balk and claim price gouging. Consumption drops, and the supply begins building once again.

This is an overly simplistic model, but it does make the point that what consumers think they want and what they actually want can be two different things. People want stable energy prices. Magnified a hundred fold, industry, which relies heavily on cheap reliable sources of oil and gas, cannot accurately plan their business without a clear understanding of what their energy costs will be. Everything from steel and fertilizer plants to plastics producers and trucking companies look at petroleum prices as one of their key economic considerations.

Considering that fluctuations in petroleum prices affect both end-line consumers and industries outside the energy sector, it is no surprise that without a clear energy policy it will be very difficult for the US economy to stage an organized recovery. Federal Reserve Chairman Alan Greenspan has said as much in his testimony before the US House of Representatives, and President Bush has made a national energy policy one of his priorities.

While the implementation of such a policy would have far-reaching consequences, it would almost certainly be of benefit to the upstream offshore market. Price stability and clear signals from the administration would give operators the much-needed confidence to increase drilling and exploration programs both domestically and abroad. It could even offer some relief from the cyclical nature of the industry. After all, this is basically an offshoot of the discrepancy between supply and demand. If operators are given a clear idea of what their production will fetch at the market, they can plan accordingly, green-lighting new projects and increasing output from existing fields. Such decisions are currently risky, since there is little certainty about future consumer demand, future overseas supplies, and thus future commodity prices for oil and gas.

Not only would this benefit the US economy and the energy industry, it would provide a much more stable future for the country in terms of domestic production. By presumably supporting domestic production (with an eye toward price stability) the administration would make the US energy market more independent while at the same time increasing security of the energy supply.

Any who doubt this program would work should consider the current mood in the US with regard to energy pricing. Prices at the gasoline pump are stable now and have been for quite some time. They may be a bit higher than in past years, but consumers for the most part are not complaining. Operators are reporting increases in profits, proving that they can certainly live with $30/bbl oil, and the US economy appears to be on the mend. While this is no doubt a temporary period of homeostasis, it does show how important stable energy prices are, not only for economic growth, but also for peace of mind.

William Furlow

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