WSJ- DOW JONES NEWSWIRES 10/18/2004
WASHINGTON -- Federal Reserve Chairman Alan Greenspan said Friday he's not worried by the rise of crude-oil prices to a record $55 a barrel, saying the U.S. economy is much less vulnerable to such surges than it was in the 1970s.
In a speech to the National Italian-American Foundation, Greenspan warned that the risk of economic trouble may grow if "oil prices were to move materially higher." But so far, he said, the effect has been small. Higher oil prices have trimmed U.S. gross-domestic-product growth by about three quarters of a percentage point. But prices are likely to recede over time, he said.
"Part of the recent rise in spot prices is expected to wash out over the longer run," Greenspan said, citing the fact that prices of crude for delivery in 2010 remain well below spot prices. Technological innovation, moreover, will ensure "the needed supplies, at least for a very long time," he said.
The remarks suggested the U.S. central bank will persist with its campaign of higher interest rates despite sharply higher oil prices. Crude-oil prices have climbed about 40% in the last 12 months, but the economy has continued to expand at a pace Fed policymakers consider acceptable. The Fed, accordingly, has raised its key interest rate three times since June and is expected to raise it again next month.
Greenspan attributed the increase in long-term oil prices mostly to "rising geopolitical concerns about insecure reserves and the lack of investment to exploit them." Insurgent attacks on Iraq's oil infrastructure and civil unrest in Nigeria have fanned worries about the outlook for supply because oil-exporting nations already are operating near the limits of their production capacity.
But Greenspan also cited a "speculative" element to the price increase. "Heightened worries about the reliability of supply have led to a pronounced increase in the demand to hold larger precautionary inventories of oil," he said. Moreover, "demand from investors who have accumulated large net long positions in distant oil futures and options is expanding again."
"Such speculative positions are claims against future oil holdings of oil firms," he said. "Currently, strained capacity has limited the ability of oil producers to quickly satisfy this markedly increased demand for inventory."
But the outlook isn't all bleak, he said. Technological advancements have led to the discovery of 100 billion barrels more of oil than was produced over the last decade, he said. "The uptrend in world proved reserves is likely to continue at least for a while," Greenspan said.
Moreover, investment in improving the capacity of oil refineries is growing - a development Greenspan said will help expand the supply of refined oil. Many refineries are designed to process high-quality crude oil but the recent increases in output have been in lower-quality crude, leading to a spike in prices for higher-quality oil.
Greenspan also said that if oil prices stay high, they will induce a change in consumption patterns that will make the high prices unsustainable.
"Much of the capital infrastructure of the United States and elsewhere was built in anticipation of lower real oil prices than currently prevail or are anticipated for the future," he said. "Unless oil prices fall back, some of the more oil-intensive parts of our capital stock would lose part of their competitive edge and, presumably, be displaced, as was the case following the price increases of the late 1970s."
Greenspan said predictions of catastrophically high oil prices have often turned out to be wrong in the past. In the 1970s, he said, the U.S. Department of Energy predicted that oil prices would rise above $100 a barrel, measured in current dollars. That never happened.
"The failure of oil prices to rise as projected in the late 1970s is a testament to the power of markets and the technologies they foster," Greenspan said. Adjusted for inflation, today's oil prices are three-fifths of their level in 1981.
Under the circumstances, he said, "the impact of the current surge in oil prices, though noticeable, is likely to prove less consequential to economic growth and inflation than in the 1970s."
