We Must Address Oil-Market Volatility

We Must Address Oil-Market Volatility. By GORDON BROWN and NICOLAS SARKOZY
Erratic price movements in such an important commodity are cause for alarm.
WSJ, Jul 08, 2009

For two years the price of oil has been dangerously volatile, seemingly defying the accepted rules of economics. First it rose by more than $80 a barrel, then fell rapidly by more than $100, before doubling to its current level of around $70. In that time, however, there has been no serious interruption of supply. Despite ongoing conflict in the Middle East, oil has continued to flow. And although the recession and price rises have had some effect on consumption, medium-term forecasts for demand are robust.

The oil market is complex, but such erratic price movement in one of the world's most crucial commodities is a growing cause for alarm. The surge in prices last year gravely damaged the global economy and contributed to the downturn. The risk now is that a new period of instability could undermine confidence just as we are pushing for recovery.

Governments can no longer stand idle. Volatility damages both consumers and producers. Those who rely on oil and have no substitutes readily available have been the victims of extreme price fluctuations beyond their control -- and apparently beyond reason. Importing countries, especially in the developing world, find themselves committed to big subsidies to shield domestic consumers from potentially devastating price shifts.

In Britain and France we also know how the price of crude dictates the price of petrol at filling stations and the effect on families and businesses. For countries heavily reliant on income from oil exports, the windfalls from brief price surges are offset by the consequent difficulties of planning national budgets and investment strategies.

Extreme fluctuations in price are encouraging energy users to reconsider their reliance on oil. The International Energy Agency, for instance, has cut its long-term forecast of oil consumption by almost a quarter. Producers are in danger of finding that their key national resource loses both its market and its long-term value.

More immediately, we as consumers must recognize that abnormally low oil prices, while giving short-term benefits, do long-term damage. They diminish incentives to invest, not only in oil production but also, in our own countries, in energy savings and carbon-free alternatives. As such, future problems are stored up in the form of shortages, greater dependence and an acceleration of global warming. Upstream investment worldwide is already down by 20% over the past year. And with some sources of supply in decline, such as Alaska and the North Sea, the resource we will all need as the economy recovers is being developed in neither an adequate nor a timely way.

There are no easy solutions and any progress must be made with the full co-operation of the world community and the oil industry. On Monday we used the U.K.-France summit in Evian to explore a way forward. We hope our ideas inform meetings both today, at the Group of Eight Summit in Italy, and in future talks between world leaders.

We are committed to intensifying the ongoing dialogue between producers and consumers through the International Energy Forum. Saudi Arabia and OPEC have expressed interest in this and we believe producers and consumers are closer now than at any time in the past 30 years to recognizing the huge common interest in giving clear and stable perspectives to long-term investment.

At the London Energy Meeting last December, all participants agreed that still closer co-ordination between the IEA, OPEC and the IEF was necessary to develop a shared analysis of future demand and supply trends. The Expert Group of the IEF should use this work to arrive at a common long-term view on what price range would be consistent with the fundamentals.

The experts should also consider any measures that could be put in place to reduce volatility. Discussions should look again into the question of whether trading activity is amplifying erratic price movements.

We therefore call upon the International Organization of Securities Regulators to consider improving transparency and supervision of the oil futures markets to reduce damaging speculation and to take forward the recommendations already made by its taskforce in March. This would serve the interests of orderly and adequate investment in future supplies. Volatility and opacity are the enemies of growth. In the absence of transparency, consumers and importing nations are losing confidence in oil. Climate change is also altering government attitudes to energy.

The world's economy is still reliant on secure supplies at prices that are not so high as to destroy the prospects of economic growth but not so low as to lead to a slump in investment, as happened in the 1990s.

It is a thorny issue, but complex markets need not be volatile or damaging to the wider global economy. We are convinced that producers and consumers alike would benefit from greater transparency, greater stability and greater consensus on the market fundamentals. After two years of destructive volatility the time has come for both sides to work together to build on this common interest.

Mr. Brown is prime minister of the United Kingdom. Mr. Sarkozy is president of France.