The Fed, Interest Rates, Inflation, And Energy

[FC]

From Investor's Business Daily

Crude Lessons

 

 

 

Economy: All eyes are on the Fed, which surely will lift interest rates when it meets today. But regardless what the central bank does, it won’t suffice. We need to get cheaper, and more, energy on the market, and fast.

 

 

 

 

As usual, history has something to say about our situation. Though core inflation remains low at 2.4%, there are reasonable concerns that the trebling in oil prices over three years could lead to a surge in prices across the economy.

With that backdrop, the Fed embarked two years ago on a series of rate hikes, 17 in all, raising the benchmark fed funds rate from 1% to above 5%, expected as of today. And it may not be done yet.

But the Fed’s battle against inflation is likely to run aground when met by a harsh reality: It doesn’t control oil prices. The Fed is raising rates to take down inflation in the part of the economy not related to oil. We thus could be hit with a double-whammy: slowing growth in the non-oil economy, and continued high prices for oil.

Not a pleasant scenario. Indeed, the worst of all possible worlds. But not without parallels.

In 1981, the U.S. was in the grips of a vicious double-dip recession, the worst since the Depression. Inflation soared while output plunged. Oil prices were widely expected to double. Fed chief Paul Volcker, who took over the Fed in 1979, had slammed on the economy’s brakes, letting interest rates soar above 20%. Yet inflation stayed stubbornly high (see chart.)

Faced with this, in January of 1981, barely one week into his first term in office, President Reagan did what few thought he should do: He decontrolled the price of oil and gas. At the same time, he jawboned the Saudis to ramp up oil output, from 2 million barrels a day to nearly 9 million.

The strategy worked stunningly well. Along with his tax cuts, Reagan’s push to get more oil on the market set off a remarkable noninflationary economic boom that’s still felt today. Those moves reshaped a sickly economy and turned it back into the world’s leader.

And oh yes: Oil plunged 40% in four years. In fact, the ’80s peak in real oil prices came the very month Reagan decontrolled them.

At $70 a barrel, today’s high price of crude will once again lead to more supply — if we’ll let the market work its magic. (Indeed, it already is: A recent report from ISI Group, a Wall Street investment house, estimates non-OPEC oil supply will grow nearly 2 million barrels a day in 2007 — the biggest rise since 1978.)

The world uses about 85 million barrels a day but has more than 2.5 trillion in reserves. The U.S. uses about 20 million barrels a day, but produces just 8 million of that. So we depend on the rest of the world for more than half of our oil. At the same time, world demand is growing 1.5%-2% a year. Simply put, we need more energy.

Congress doesn’t need to look to OPEC or the Fed to handle this problem. It has the power to make an enormous difference in our energy security, right away. It can start by developing both the continental shelf and the Arctic National Wildlife Reserve.

Like Reagan’s actions 25 years ago, these and other moves could make a much bigger dent in energy prices, and therefore inflation, than mindlessly keeping ever-tighter credit on automatic pilot.

 

[fritz]

Yes, oil prices went down in the early eighties, and oil companies stopped exploring in my area. That is one reason why Shell dry-holed a deep well next to me in 1982, the cost of producing it wasn't going to be met with the decline in oil and gas prices.

 

What's good for the goose is not necessarily good for the gander, at least in the oil business. Not until oil went up did the companies come back here and start drilliing again. Now it's my turn to reap what has been taken from me years ago.

 

Where's that rig?

 

fritz

[FC]

I wonder if another company, like Greater Sooner Holdings, Inc., could drill there?

[fritz]

"I wonder if another company, like Greater Sooner Holdings, Inc., could drill there?"

 

Never heard of them. But my lease is with Chesapeake Operating out of OK City, and they are bringing in wells all around me, all deep, around 12 to 16 thousand feet. I had a bit of legal trouble with them a month ago on delay rentals, but with the help of a lawyer they coughed up some more money. They are going to have to make a new lease or drop it come spring. I don't see them dropping it, what with wells all around me.

 

All that and six bits buys me a cup of coffee at the DQ.

 

I hope you didn't get suckered in like some investors with little independants did in the 70s. HM Oil Co. out of Houston came in and drilled two 4,000' wells on some land I owned. A lawyer and an architect put up the money to drill because this area was where the action was.

 

I still remember the architect arriving with a six pack and a bucket of KFC, wanting to see the log. I explained to him that it would take several hours before they were ready to log. He could not comprehend that, since he was an architect and could do it faster.

 

Well, around midnight the big shot from HM arrived (he knew how long it would take to get the log). In the meantime, the architect kept saying he hoped it was oil, since oil was selling for over $40 per barrel. It took all my patience to explain to him that this well bottomed at 4,000' and the nearest oil was at 5600'.

 

I told him that this well was a GAS well, and to forget oil. It turned out to be a flop, but guess who lost money--the investors and not the oil company. In fact the big shot had his son drill the well, all at investors expense.

 

Hope your mileage differs.

 

fritz

[FC]

 

I already made a fair amount of money out of them, and I'm hoping to do it again. They closed on Clayton Field Thursday, I think, and have their state licenses.