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A Crude Predicament: The Era of Volatile Oil Prices

by Michael Levi
June 13, 2011

There has been no shortage of reporting over the last week on the fight within OPEC over whether to expand oil production. Bob McNally and I have an essay in the forthcoming (July/August) issue of Foreign Affairs in which we argue that OPEC has largely lost the ability to moderate oil price swings. The result is the far more volatile oil market that we’ve been seeing over the past five or so years. This is a fundamentally different world from the one that Americans became used to in the 1980s and 1990s, and will require different responses from policymakers.

Here’s the nut of our argument:

“Much of OPEC’s influence is gone. Saudi Arabia and its partners no longer consistently hold the large volumes of spare capacity they once did. And there are no ready replacements waiting in the wings. The oil market is in for a rocky ride, with major economic and geopolitical consequences: underinvestment in the development of energy, greater economic sensitivity to geopolitical unrest in oil-producing regions and shipping lanes, and a higher risk of recessions. The United States will find it impossible to eliminate price swings in the coming years, and so it will need to learn to live with them as best it can.”

We then discuss the sources of volatility (Saudi Arabia no longer has the same means or motive to stabilize markets that it once did), the potential consequences (more difficult investment decisions for individuals and firms, a trickier climate for monetary and fiscal policy, greater sensitivity to geopolitical unrest), and appropriate policy responses (which need to encourage a mix of robust and dependable supply, decreased demand, and better functioning physical and financial markets). There’s a lot more detail in the piece, some of which I’ll discuss in subsequent posts, but for now, I encourage readers to take a look. (The piece is behind a pay wall, but if you use the link in this post, you’ll get it for free, at least for a while.) I’ll also have something to say in later posts about a few ideas that we didn’t manage to squeeze in.

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