European Affairs

As Laurent Fabius, the French Finance Minister, has stated, recent tax cuts on oil to offset the price rise were aimed at managing a sensitive political situation. They must not be misinterpreted as a change in European energy policy.

If you look in the dictionary, "crisis" refers to a situation in which something or someone is affected by one or more very serious problems.

With this in mind, we cannot say that Europe faces an overall energy crisis. The outlook for the European Union is quite good, although, like many countries around the world, we must change our current thinking about the oil market and prepare public policy to deal with new challenges.

Higher oil prices should not disrupt the balance between supply and demand for energy in Europe too seriously.

From 1990 to 1999, European energy consumption grew by one percent a year. Domestic production covers little more than 50 percent of requirements, and this import dependency has remained unchanged since 1990.

Although dependency on imported oil declined from 80 percent to 75 percent during the 1990s, it is expected to rise again to 85 percent by 2020. Dependency on imports of natural gas remained stable at 41 percent during the same period.

Even though energy policy remains essentially the prerogative of national governments, a number of measures are being introduced in the context of the EU single market to encourage competition between suppliers and to bring down production costs. Liberalization of the electricity and gas markets has been the main achievement of this policy since1990.

The next step will be to agree a common framework for taxing energy products in order to set the minimum tax levels necessary to promote environmentally responsible behavior and energy savings.

Maintaining competitiveness will be especially important. The EU cannot allow its economy to be permanently undermined by volatility in the price of a raw material on which it is overly dependent

As Romano Prodi, President of the European Commission, has stated: "On such vital questions, the European Union has to follow policies which are both more daring and more consistent. Issues related to oil supplies should not be treated individuallyƒ". Europe cannot avoid a wide-ranging discussion on its energy supplies and its transport policy.

But a crisis does not mean only a high price level. If there is a crisis, it began with the 1998 price collapse.

Thanks to new technology and productivity gains, and intensified competition among producers, there is a prospect that oil will be cheap and plentiful in the foreseeable future. We can expect the price of oil, like prices of most other commodities, to fall slowly over the years.

But even if we think that oil market competition is desirable, we must remember that our strategic interests also require peace and stability in the producing countries, which are mostly in sensitive areas, such as the Middle East. In this regard we must be concerned as much by low as by high prices.

We can pose the following questions: is action by the Organization of Petroleum Expor-ting Countries positive or negative for the world economy? Does OPEC really lead oil markets? Do we agree with those who argue that OPEC deserves some sympathy because it has to deal not only with a flood of non-OPEC oil and gas, but also with political and military conflict among its own members?

Hasn't OPEC won the fundamental argument with consumers that it is much better for the world economy to have a stable oil price than to allow the free market to produce very sharp price swings that create imbalances between supply and demand?

Have sanctions against Iran, Iraq or Lybia held back growth in world oil supplies? How can the market provide enough oil to meet growing demand if the oil companies are not allowed to invest in countries with abundant, cheap resources?

We should ask what causes market imbalances. Is it the unexpectedly strong growth in world demand or regional bottlenecks caused by lack of transport capacity, of refinery capacity or of storage? Or is the problem a shortage of the right kind of crude oil?

We should also examine the oil companies' strategies in response to fluctuating oil prices.

Joseph Stanislaw, a leading energy consultant, wrote recently in Business Week that "oil companies have to look for the business model that will capture the most investor attention." It seems that this model is no longer "long-term volume growth."

Today, competing with Internet stocks, oil and services companies must look for higher returns. Is not this the main reason for the investment slowdown in recent months and the decrease of oil stocks held by refiners?

Will "just in time" inventory and delivery systems, made possible by new information technology, have a long-term impact on market equilibrium? Does the futures market play a part in volatility? Must governments fight speculation? Is there collusion requiring antitrust enforcement?

On the other hand, what role does the lack of market transparency play in price volatility? How can operators and governments make the right decisions without good information?

In contrast, can we agree with the thesis advanced by Philip Verleger, an oil market economist, and others, that financial data about a company can provide a surrogate for information about its physical inventory, and that speculation generally improves the liquidity and efficiency of markets?

Finally, what part does tax policy play in the current situation? Tax, of course, is revenue for the public budget, but isn't it also a basic tool to manage the protection of the environment and scarce resources by facilitating alternative energy development?

To deal with some of these issues, the European Commission is suggesting a common strategy on oil supply consisting of five types of measures:

  • More open relations with oil-producing countries. A dialogue with producing countries could help to establish stable prices by providing more transparency. The Commission also proposes to increase cooperation with Russia.
  • Improved market mechanisms to prompt producer countries, market operators and the energy industry to improve indicators of price fixing. Providing more accurate information on supply, demand and stocks.
  • A stronger common approach that would include: resisting the temptation to offset oil price rises by cutting taxes; aiming to harmonize excise duties between EU member states; aligning fuel taxes with the higher rates among the member states; establishing an EU mechanism to stabilize VAT revenue in the event of major oil price fluctuations; and increasing strategic oil stocks by bringing their use into the EU framework.
  • A more diversified energy policy including a strategy to strengthen security of supply and energy-saving, and to increase finance for research and development of a new generation of vehicles and of substitute fuels.
  • An alternative common transport policy in order to allow development of the most energy saving modes of transport.

The real threat to the world economy is exaggerated price fluctuations, which result in long-term damage to the industry by making new long-term investment much more difficult and costly. It is government's responsibility to establish a stable framework that allows markets to work smoothly and efficiently.

After the liberalization of the electricity and gas markets, the EU will have to develop a strategy on oil supply in order to face the prospect of an ever-changing oil market.


This article was published in European Affairs: Volume number II, Issue number I in the Winter of 2001.