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Creating World Certainty Via Petroleum Price Stability

     By Lehrer Financial and Economic Advisory Services Litigation Support, Financial, Economic, Valuation Services

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Expert Witness: Lehrer Financial and Economic Advisory Services
The certainty created by a set price for petroleum should tend to create stability in many other sectors of the economy. Certainty in petroleum pricing should lead to certainty in the industrial sector and to a degree of certainty in the world’s financial sectors, namely less volatility for interest rates and other debt instruments. A higher level of certainty in the financial markets and the petrochemical markets should foster an arena for world growth and stability.
Above all, economies, especially highly industrialized / technological economies crave stability in order to maintain and foster their growth patterns.

Sustained business growth, consumer expenditures and governmental planning require that certain key fundamental economic elements remain stable within certain acceptable limits. The general public, aside from the consuming public also desires stability as a means of maintaining order.

Past events have demonstrated that our capitalistic economies can conduct sustained business functions extremely well either under high interest rates, or low interest rates, provided the level of interest rates is known to the decision makers over longer periods of time. What tends to hinder or curtail business activity and growth is based upon the lack of decision making authority when interest rates are variable or unstable, especially in the shorter or medium term levels. History and research have demonstrated that instability or frequent changes in an important economic factor such as interest rates, taxation rates, petroleum or government spending discourages business leaders from making decisions that move growth forwards. Investments (or expenditures) that tend to move national growth forward tend to be larger capital investments whose commitments rest upon well calculated projections and expected rats of return on investment.

In almost every major sector of a capitalistic economy, instability leads to indecision and indecision manifests itself in inactivity, resulting in lack of growth usually with increased unemployment, financial unrest and a stagnating GDP. When management is unsure of the future, especially via pricing volatility, it tends to delay important decision making activities. To protect their own positions and finances, corporate management tends to rely upon the ole adage – “When in doubt – just delay!” Clearly recent events demonstrate the viability of this principle.

Looking beyond the current economic crisis, there is the major uncertainty of petroleum pricing facing all economies. Those industries that utilize and rely upon petroleum and petrochemicals as one of their major ingredients, like the airlines, shipping, trucking and plastics, utilities and automotive production, all face significant levels of uncertainty as in the recent past and into the future. This uncertainty clearly exists beyond the current financial crisis and is resulting in the curtailment of a number of major corporate investment activities and growth opportunities.

Clearly, if the price of their basic raw materials - petroleum was a known and reliable cost ingredient on a forward pricing basis, then those in a position of decision making would clearly have a large degree of uncertainty eliminated from their decision making process. This elimination would easily allow for more rapid decisions that would manifest in immediate and sustained increased business activity, employment, income and growth.

OPEC was founded on the principle of stability, with the major aim of maintaining oil pricing at acceptable levels both for producers and users. However, recent events have demonstrated that OPEC alone can no longer provide the stability necessary to enable major users to rely on it in planning and for their investment making decisions. This is growing uncertainty is now penetrating the highest levels of our economic chain and needs to be addressed – head on.

In order to eliminate a significant amount of uncertainty, it is suggested that the price of crude petroleum be “fixed” or made “certain” over the intermediate future term. With a viable and fixed price or rate for petroleum, the uncertainty surrounding this ingredient would be eliminated and allow for a more even flowing decision making process. In order to “fix” the price of petroleum, at a mutually agreed upon viable price, the following is proposed:

Commencing (as an example) July 1, 2012, (or some agreed upon future date) the price per barrel of petroleum will be $80 per barrel. To maintain this amount, both OPEC and the United States Strategic Petroleum Reserve would stand ready, on an unlimited basis, to buy and sell in necessary quantities to maintain $80 per barrel price for the month. In effect, spot market speculation would be eliminated, as no spot players in the marketplace would have the resources to counter the forces and influence that both OPEC and the United States Strategic Petroleum Reserve could easily muster in the worlds marketplace. Further, even if OPEC and the United States Strategic Petroleum Reserves did not fully utilize their powers and abilities in the marketplace, their combined latent powers or their ability to change the market in a few minutes would be sufficient to prevent others from fostering speculative action.

Commencing approximately January 1, 2015 (or some agreed upon future date after July 1, 2012) and every month thereafter, for approximatelty twenty-four (24) months, the price of OPEC crude petroleum would be allowed to increase, say $0.75 per barrel, per month. Thus, twenty-four (24) months later, the price of OPEC petroleum would be $98 per barrel. At that time, namely January 1, 2015, OPEC, in exchange for receiving an increased price of $0.75 per barrel, per month – guaranteed - for the past two (2) years would agree and guarantee to retain the price of crude petroleum at $95 - $100 per barrel for at least two (2) full calendar years, or until January 1, 2017.

In the above manner, those industries utilizing and dealing with petroleum would now be dealing with a known quantity and at a level of financial certainty for at least four (4) full future years (until January 1, 2017). By eliminating the volatility of one of the world’s most basic consumed and required commodities, those in a position of both corporate and governmental authority could focus their attention on correcting other deficiencies such as mortgages, taxation, trade barriers and healthcare, knowing that the petroleum pricing problem has been put to rest for at least four (4) years.

The certainty created by a known or set price for petroleum should tend to create stability in many other sectors of our national and international economies. Certainty from petroleum pricing, leading to certainty in the industrial sector, should also lead to a degree of certainty in the world’s financial sectors, namely less volatility for interest rates and on a wide class of debt instruments. A higher level of certainty in the financial markets when combined with a large degree of certainty in the petrochemical markets should clearly foster an arena for world growth and stability; or at least a solid platform for current recession recovery.

At the end of the four (4) year period, depending upon the level of world economic activity a similar or even further refined stabilized negotiated pricing agreement could be reenacted for another “set” period of time. The reset time frame and any modifications made thereto, would be based upon the experiences learned from the initial agreement of 2012 - 2016/17.

In summary, the above is basically an insurance agreement contract. Those who consume petroleum are agreeing to pay a slightly higher price over time in exchange for future assurances of acceptable levels of price stability. This stability will allow projections on investment rates of returns with a degree of certainty. Such certainty will foster overall investments affording enterprises who undertake the investments based upon price certainty to earn returns on funds not otherwise employed.

Those who supply petroleum are accepting a higher price over time and for this acceptance, they clearly acknowledge that to preserve world economic stability, they must repay those who paid the higher price in the earlier years with stability and certainty. This will also allow the suppliers of petroleum to budget for their own national stability and not be subjected to wide swings, including periods of selling petroleum for little profits.

In effect, the world would have agreed to function in a way similar to that of the 1700's, where communities grouped together to offer assistance to each other in times of need under a reciprocal benevolent association arrangement. These are types of associations that clearly fostered the minimalization of risk that clearly help support and foster the national economic development we enjoy today.

Lastly, and not of minor consequences, a set or certain level for petroleum with the potential for an extension to the original agreement will go a long way towards not only fostering short term growth, economic stability and an industrial era that appears to be fading from the scene, but will clearly assist in the elimination of a “double dip” recession. If those in control of petroleum seek to recover lost profits by allowing petroleum to rise or “spike” in price, then it is extremely possible a secondary or “double” recession could come into play. Recovery from a “double dip” recession would be extremely more difficult and not worth the risk from increasing petroleum uncertainty. Hence, a stabilized price for a secured world wide society.

ABOUT THE AUTHOR: Dr. Kenneth E. Lehrer
Dr. Lehrer has been an independent Economist and Financial Consultant since 1980. He holds four degrees from New York University: Bachelor of Science (Finance), Master of Business Administration (Banking), Master of Arts (Economics) and a Doctorate in Urban Economics. After a career on the corporate lending staff of Bankers Trust Company (New York), Dr. Lehrer became a Manager for the Greek Shipper, Costas Lemos [dec'd]. Here, he assisted in a variety of projects in New York, Houston, Denver, Guam and in Europe. Dr. Lehrer relocated to Houston, Texas in 1977.

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While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.
For specific technical or legal advice on the information provided and related topics, please contact the author.

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