Oil spill. Photo by <a href="http://flickr.com/photos/esqenzo/320311357/">Jay-P</a> (<a href="http://creativecommons.org/licenses/by-nd/2.0/deed.en">CC</a>).
Oil spill. Photo by Jay-P (CC).

Policy Innovations Digital Magazine (2006-2016): Commentary: A Slick Solution for Oil Markets

Oct 16, 2008

The world has spent the last several weeks reeling from the failure of financial markets. But credit markets are not the only markets that are disobeying the laws of supply and demand. Although oil prices are declining, the global oil market is also out of whack. Oil prices remain high, causing economic suffering around the world. To get the global oil market back on track, policymakers will have to behave differently.

Oil markets do not work efficiently for several reasons. First, we don't really know how much oil we can easily tap. Most of the world's leading producers of oil and gas are not open about their supply. OPEC, for example, does not publish oil field production data. Moreover, some countries such as Saudi Arabia have refused to verify statistics regarding their proven reserves. And it's unclear whether we can trust what oil companies say about their reserves. In January 2004, Shell admitted that it had overstated its reserves by more than 20 percent. The company lost its triple-A rating and was forced to pay huge fines.

Secondly, world oil markets are tainted by corruption. In many oil producing nations, buyers and sellers of energy find it easy to conceal information about energy contracts and the revenues from those resources. This information failure can lead to market failure and significant volatility in price and supplies. Moreover, policymakers in many petro-states often demand bribes for the right to obtain their oil. Thus, the leaders of Angola, Kazakhstan, and Equatorial Guinea have invested in Swiss bank accounts rather than in their people. Their corruption generates distortions and inefficiency, undermines investment and reduces economic growth, and ultimately raises the price of gasoline at the pump.

Third, consumers don't have the information they need to make good decisions about whether to consume or how much to consume. Many countries use subsidies to protect their citizens from rising fuel prices. These subsidies allow consumers to waste fuels, such as gasoline, home heating oil, and propane, as well as the numerous consumer items made from fossil fuels, such as the ubiquitous plastic grocery bag. But consumers also are so far unwilling to pay for the true economic cost in congestion and pollution of the gasoline they consume. Thus, economists argue if you want to end our dependency on fossil fuels, we should increase taxes on energy consumers.

The U.S. government, working on its own, can't make the international oil market function efficiently. But there are steps that policymakers can take to guide markets in the right direction. First, we could use transparency to provide consumers with the information they need to make decisions about demand and prices. The higher the level of disclosure, the better investors will be able to safeguard their own interests.

Chairman Barney Frank of the House Financial Services Committee and Senator Chuck Schumer of the Senate Banking Committee introduced the Extractive Industries Transparency Disclosure Act which would require oil companies to publish what they pay governments for the right to extract oil. More than forty Democrats and Republicans have signed on as cosponsors of the bill.

In addition, the United States could provide significant support for new international accounting rules that would show energy firms how to disclose the revenues paid by oil companies. This would put pressure on governments to publish what they earn and give citizens the information they need to demand greater accountability from their local officials. That in turn should reduce the opportunities for government officials to demand bribes from oil companies.

Oil may be the fuel that lubricates the world's markets, but the market for oil is far too greasy. Better governance could be a slick solution.

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