IT’S TOUGH attending dinner parties these days. Until recently, all an economist had to cope with were requests for forecasts on house prices — for each of the neighbourhoods represented at the table. Now things are harder. Every guest has his or her own reason for wanting a forecast of oil and petrol prices.

Politicians in America are convinced that the price of petrol will determine which party controls the House of Representatives after the November elections. Republicans profess to see the recent price drop of about 50 cents per gallon reflected in a rise in their poll ratings.

Monetary-policy types also want to know about oil prices. The recent decline, they say, provides ammunition to the members of the Federal Reserve Board’s monetary policy committee (and their counterparts at the European Central Bank) who want to extend the “pause” in interest-rate increases as they battle the inflation hawks who are arguing for one more rise.

Oil-industry executives are naturally eager to peer into the future. They are using the recent drop in oil prices — down by about $15 a barrel — to prove that markets are finally working as they should. And the Opec cartelists are citing the price plunge to prove three things.

First, prices never really were as high as the industry’s critics contended. Even when the oil price reached $78 a barrel in July, it was still far below the inflation- adjusted price of almost $100 a barrel that it hit in April 1980.

Second, the price drop shows that the markets are retreating from the nervousness created by the “peak oil” crowd that has been arguing that the world is running out of oil. So there is no need to subsidise oil substitutes.

Third, the drop in prices has allowed the cartel to indicate to its members that they are free to cut back production as demand for oil dictates. Translation: don’t produce so much as to encourage further drops in oil prices. So much for Opec’s now-forgotten pledge to keep prices below $30 a barrel.

Most important to the cartel, the decline in prices eases the political pressures on them. The Saudi regime, after all, still counts on the American military to defend it should Osama Bin Laden or others attempt a coup. Never mind that it is the Saudis who fund the worldwide teaching of the Islamic fundamentalist creed that fuels the anger of the terrorists: America’s oil addiction requires it to support the House of Saud much as a drug addict’s habit requires him to support his dealer-pusher.

It does seem that forces on both the demand and the supply sides of the market are starting to make themselves felt. On the demand side, thousands of unsold 4x4s and pick-up trucks dot dealers’ lots as consumers shy away from these fuel-thirsty vehicles. On the supply side, $60-$70 oil has encouraged Chevron to drill deep under the Gulf of Mexico, and uncover a field that might contain as much as 15 billion barrels of oil, adding 50% to US reserves. Even a loyal Russian KGB apparatchik knows the difference between $20 oil and $60 oil: Putin has announced that Russia will spend $100 billion (£53 billion) over the next decade to shore up his nation’s ability to get oil to market.

But an easing of demand and increases in supply do not necessarily portend a return to the era of cheap oil, as a quick review of the potential sources of supply indicates:

• In America, environmentalists continue to block development of reserves in Alaska, and cite BP’s environmental and safety problems as an added reason to leave the caribou undisturbed.
• In Venezuela, production will continue to decline as Hugo Chavez’s political appointees prove unable to operate the nation’s oilfields as efficiently as the technicians he fired.
• In Mexico, the government refuses to allow the gringo investment that it needs if it is to reverse the declining productivity of its oilfields.
• In Iraq, terrorists continue to blow up oil facilities, preventing that country from achieving its production potential.
• In Iran, the mullahs and their firebrand president threaten to shut down their fields, and even close the waterway through which most of the world’s oil travels if anyone were to interfere with their drive to obtain nuclear weapons.
• In most of the Middle East, where the great bulk of the yet-to-be-discovered reserves lie under desert sands, western investment and technology have been barred, bringing into question future production capabilities.

  Only Canada holds the promise of significant, trouble-free supplies.

  So we are not dealing with a market of the sort Adam Smith had in mind when he described how supply and demand interact to set prices. It seems highly unlikely that the risk premium reflected in oil prices will disappear any time soon. So Rodrigo Rato, managing director of the International Monetary Fund, is probably right when he warns: “Oil is going to continue at high prices (in comparison with two to three years ago).”

  That will have repercussions far beyond oil markets. Wealth will continue to be siphoned from consuming countries to producing ones, enriching the Saudi fundamentalists and the likes of the trouble-making Chavez. Russia will be able to replace its clapped-out military with dollars, euros and yuan as a source of geopolitical power, witness its purchase of an interest in EADS, the European defence firm that makes ballistic missiles for the American military.

  America’s trade balance will continue to suffer from the outflow of dollars needed to pay for the inflow of oil. And its ability to defend the West in its war on terror will hinge on the willingness of Arab and other hostile states to provide the fuel on which its economy depends, and which its armed forces need for their Humvees, drones and other equipment.

  Oil addicts do indeed pay a high price to avoid the temporary withdrawal symptoms that a sensible energy policy would produce. o Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute

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