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Monday, Oct. 16, 2000

Smoothing out crude oil price fluctuations


Crude oil continues to soar at prices above $30 per barrel, casting dark clouds over the world economy. In Japanese Perspectives on March 27, I said the causes of this unusual phenomena are not only real demand for oil, but also speculative trading encouraged by excessive liquidity.

When too much liquidity is injected into a specialty market like crude, it is like releasing a whale into a pond.

The recent surge in oil prices may not be as sharp as the first oil shock, when prices nearly quadrupled, but it is already steeper than the second one, where prices roughly doubled.

Unlike the European Union and its depreciating euro, and the United States with its huge current account deficit, the surge's impact on Japan has so far been limited.

Here are the major reasons: First, Japan's shift from heavy, smokestack industries to a more diversified array of lighter industries has made its economy less dependent on oil. Japan has also become twice as energy-efficient since the 1970s.

Second, the nation has built up a stockpile of oil large enough for 160 days of normal consumption, compared with less than 100 days in the 1970s.

Third, deregulation and competition with imports have dampened any rise in domestic oil products.

A fourth factor is the yen, which was relatively weak against the world's major currencies when the first two oil crises struck but remains strong today, keeping yen-denominated oil prices stable.

Nevertheless, it is undeniable that surging crude oil prices are a negative factor for the world economy, and from a long-term viewpoint appropriate measures must be taken to stabilize them.

I would like to make the following suggestions: In financial terms, policymakers should realize that rising oil prices mean serious inflationary pressure and that they should start reigning in excessive liquidity.

If the U.S. stock market becomes filled with uncertainties, excessive liquidity that had been injected into securities could well pour into crude oil and other commodities markets. And that kind of influx could distort the markets' normal price-formulation mechanisms. To limit large-scale price fluctuations caused by speculative trading, a circuit-breaker system like those used in stock exchanges may be necessary.

There is also a need to make supply-and-demand adjustments from a long-term perspective. A price zone for crude oil (between $15 and $25 per barrel under current conditions) should be introduced.

Oil-consuming countries need to make such efforts not only when prices surge, but when they dip below $10 per barrel, as was seen in early 1999. Otherwise they cannot count on the cooperation of the oil-producing nations. Nations with surplus foreign exchange reserves should consider a demand-stabilizing mechanism in which they would expand their oil stockpiles when prices are low and release it to the market when prices are higher.

One idea would be for oil-producing and -consuming countries to hold a forum either before or after meetings of the International Monetary Fund.

As in efforts that have been made to stabilize foreign exchange, it is uncertain whether such measures will always produce the desired effect. But the launch of one tool to reign in the market will at least help discourage speculators.

Finally, we should pursue efficiency in the use of crude oil and rectify the international gap in the taxation system as part of competition policy -- matters that relate to environmental issues.

Faced with the recent surge in crude oil prices, some countries have tried to adjust through taxes. But oil-related tax rates differ widely among Japan, the European Union and the United States. Rising oil prices may provide a good opportunity to encourage discussion on the need for a level playing field in this area.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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