Why More Saudi Oil Could Harm American Consumers

The Saudis and other oil producers want to prolong—not break—our addiction to oil.

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This guy walks into a bar. He's an alcoholic who's trying to kick the habit. The bartender knows that. But the guy is also a reliable customer who directs a good chunk of his disposable income to the bar's cash register. So what does the bartender do? Pour him another drink: It's somebody else's job to deal with the guy's addiction.

They don't drink in Saudi Arabia—not officially, anyway—but the Saudis sure know how to nurse an addiction. Ours, that is. American and European officials are expressing thanks and relief, now that the Saudis have pledged to boost oil production by about 0.2 percent—two one-thousandths—of the daily global demand for oil. The increase in supply is so puny that it's hard to see how this will make a penny's worth of difference, given that demand for oil seems to be rising faster than supply. Yet the Saudis, in this tableaux, are the good guys, doing everything they can to help ease the pain for Americans paying $80 to fill up their SUVs.

But the Saudis and other oil producers are helping themselves more than anybody else by nudging up the supply of oil. Keep in mind, when it comes to oil, we're not the Saudis' allies, and we're certainly not their friends—we're their customers. They've got us over a barrel, so to speak, and they want to keep us there. Like any good businesspeople, their strategy is to extract as much money as they can from a captive clientele, for as long as possible.

As the Saudis surely know, there's an optimal price point that will keep America addicted to oil for the longest possible time. Call it the Optimal Addiction Price. The OAP is not the highest possible price. Far from it. In fact, high oil prices might be good for oil producers now but doom them in the future. That's because expensive oil forces businesses and individuals to use less oil and gasoline. As gas prices rise, demand increases for alternatives, like electric cars, biofuels, and hydrogen, which might seem expensive in the prototype phase but could turn out to be much cheaper if mass produced.

Oil and gas prices have already become high enough to change the way people live and do business. Airlines watching their fuel bills double are canceling routes, mothballing their thirstiest planes, and laying off workers. Hundreds of companies are changing their operating plans as the cost of transporting components and finished products skyrockets.

The transformation is most pronounced in the auto industry. Car buyers are fleeing big pickup trucks and SUVs, flocking instead to hybrids and smaller cars. General Motors and Ford are radically retooling their fleets, closing SUV production lines and rushing plans for cars that get better mileage. The race is on for a car that runs on anything besides gasoline—because with gas at $4 per gallon or higher, the rewards for a breakthrough are high. Most surprising, Americans are becoming downright European and buying less gasoline, reversing a long string of annual increases in gas consumption.

This is bad news for oil producers. Sure, they're minting money at the moment, getting two or three times the price for their product that they were a few years ago, even though their costs have stayed roughly the same. But oil is drifting well above the Optimal Addiction Price—the price consumers are willing to pay without changing their driving habits or buying behavior too much. It's hard to say what that price is exactly, but consumers started to change the way they drive and buy cars once gas prices passed about $3 per gallon. There's always a lag in the purchases of costly products like cars, so let's call $2.50 per gallon the Optimal Addiction Price—high enough for producers to make a fortune, but not high enough for consumers to make big changes and look for alternatives.

The Saudis certainly have their own version of the Optimal Addiction Price—which they're not sharing with us. But clearly we've surpassed that price. So they need to produce more oil and find other ways to bring the price back down closer to global comfort levels. In addition to the tiny short-term boost in production, the Saudis have also said that by 2018, they hope to increase overall production capacity by about 32 percent, to about 15 million barrels per day.

There are many who hope we won't need it. Engineers at Toyota, GM, Honda, and other automakers think that within 10 years, technology breakthroughs could easily generate affordable, mass-produced cars that run on electricity or hydrogen and get far more output per dollar of energy than today's gas-powered cars. If gas prices keep going up, those breakthroughs could come sooner—and there won't be much upside for the Saudis and other oil producers. If gas prices come back down, those breakthroughs might not happen at all.

So if you earn your livelihood on oil, it seems like a pretty good time to crank open the spigot an extra notch, and try to convince your customers you care about their woes, you really do, and you're going to give them a little price break.

Another drink, anybody?