The economy this time - effect of Middle East crisis on oil prices and energy policy

THE OIL SHOCKS of the Seventies sent the economy careening into a decade of inflation, stagnation, and finally, sharp recession. This time, with a little help from our friends, the economic damage is likely to be minimal. The most persuasive reason for optimism, at least in the short run, is the quick, orderly manner in which oil prices increased-and then fell. To some, the increase was price-gouging. To others, it was anticipatory pricing. However you characterize it, an immediate price increase is infinitely preferable to the fear of higher prices.

Seventeen years ago fear prevailed. Oil traded at official prices; the industry was caught in a web of price controls and regulations. Today prices respond instantaneously to the shouts and gestures of an army of international oil traders, the results quantified and transmitted globally via computers. It's a lot messier than in the Seventies, but we have no hoarding, no panic, no gas lines. And there won't be any unless congressional populists succeed in restoring the regulatory bureaucracy.

Inflationary pressures will worsen, with about one percentage point tacked onto the consumer price index if prices remain at $25 per barrel for the rest of the year. Under price controls, however, the standard of living would have fallen severely. Just consider that for a couple of dollars more per tank of gas, consumers are saving themselves hours lined up at gas stations. The time, as any Russian housewife will tell you, is worth more than the money.

In contrast to 1973 and 1979, the world is awash in excess production capacity. Saudi Arabia and Venezuela alone can pump an additional three million barrels per day, replacing more than half the lost Iraq/Kuwait production. Other nations can easily fill the remaining gap. In the meantime the Western nations can draw down their enormous storage stocks, a reserve they sorely lacked in the Seventies. With oil prices rising faster than inflation the incentive to conserve oil will increase. And unlike earlier shocks there is no evidence of an actual cutback in production, meaning there may be a glut of Iraqi and Kuwaiti crude once the crisis passes.

Conspicuously missing from the list of things to be thankful for this time around is the condition of the U.S. oil industry. Domestic oil production has decreased 20 per cent in the last five years, and is currently at its lowest level since 1962. It's not that we're running out of oil: as many as three hundred billion barrels he unrecovered in abandoned wells, according to the Department of Energy. But extraction costs are prohibitive, and most experts do not see domestic production turning around until we have oil at $40 a barrel.

That price threshold can be lowered, however. The complete deregulation of natural gas and the opening of more federal lands to drilling, including offshore areas, and perhaps even the Arctic National Wildlife Refuge, should be among the first steps. We might also restore the depletion allowance and tax credits for new oil and gas drilling, most of which were eliminated by the 1986 tax reform. President Bush's close ties with the oil industry should not restrain him from pushing hard for this now.

Finally, Saddam Hussein's wakeup call should push that great unmentionable-nuclear powerback onto the nation's energy agenda. In the 12 years since the last plant was ordered, safer, cheaper nuclear-power-plant technology has been developed. A nation increasingly concerned with global warming, acid rain, and oil spills-not to mention Middle Eastern madmen-may finally be ready.