-- Alexander Smith is a Reuters columnist. The opinions expressed are his own --

Abu Dhabi is not going to crow publicly over Dubai's troubles. But it will use the opportunity to assert control over its upstart neighbor. The price for Abu Dhabi's help could be prize assets like airline Emirates. Dubai has little choice but to do what it is told.

Dubai is unable to service the $80 billion debt it has amassed during its meteoric rise to wannabe global financial hub. Oil-rich Abu Dhabi holds the political and financial trump cards. Not only is it the capital of the United Arab Emirates, its ruler is head of the UAE's seven desert states -- squeezed between Saudi Arabia and Oman.

Dubai's success threatened the balance of power between the two emirates. Abu Dhabi has developed quickly, but not at the speed of Dubai, where until a year ago new skyscrapers popped out of the desert every few days.

A property market crash and the end of free-flowing credit have taken their toll. Abu Dhabi has already lent Dubai at least $10 billion and another $5 billion indirectly via two of its banks. That won't be the end of it. Dubai has nowhere else to turn, particularly now it has alienated the international capital markets by admitting it can't meet the debts of flagship holding company Dubai World. Abu Dhabi can afford to bail out Dubai, but it has not been immune to losses itself and won't be signing blank checks.

Abu Dhabi won't want to see its neighbor sink -- after all they belong to the same country. But it will feel Dubai needs to be taught a lesson.

One particularly painful punishment would be to force Dubai to hand over control of its prized Emirates Airline through a merger with Abu Dhabi carrier Etihad Airways. Global ports operator DP World is another asset Abu Dhabi should think about laying its hands on. Indeed, ownership of such assets may already have changed hands without anyone other than the royal families knowing about it.

Other changes will be more subtle. Dubai has attracted overseas financial services companies with tax breaks and the relative freedom to do business in the way they are used to in Western countries.

Curbing some of the excesses which have accompanied this influx of people and money will also be on the agenda.

With the two cities an hour or so apart along the coast of the Persian Gulf, greater cooperation and coordination on development and direction should ultimately be beneficial to them both. Dubai's moment in the sun has passed, now is Abu Dhabi's chance to move out of its shadow.

Ryanair's warning that things are going to get worse in Europe's economies has understandably got investors in airline shares flustered. The airline's own shares fell by more than 8 percent.

The low-cost airline's finance director Howard Miller couldn't have been more stark in his comments: "There are no signs of recovery in any country across Europe. We think things are getting worse. There are no signs of green shoots so a tough winter for everyone".

At least Ryanair still reckons it will be profitable -- with net profit of around 200 million euros -- for the year as a whole.

That's more than can be said of most other European airlines, who must be increasingly concerned by Ryanair's resilience. Ryanair points out that it has "only" 10 percent of the total European market so far -- giving it plenty of scope for gains.

Ryanair's earnings have been helped by lower fuel costs, and chief executive Michael O'Leary should be heartened by a Reuters poll of oil supply and demand forecasts for 2010 which shows the oil market is set to remain well supplied until then.

And with plans to increase its fleet to 300 from 200 by 2012, it looks as though you'll be seeing more not fewer of the airline's planes -- with their distinctive gold harp logo -- flying overhead.

-Arvind Ganesan is the Director of the Business and Human Rights Program at Human Rights Watch. The opinions expressed are his own.-

Equatorial Guinea is a tiny country of about half a million people on the west coast of Africa, but is the fourth-largest oil producer in sub-Saharan Africa.

Most of the investment in the country’s multi-billion dollar oil industry comes from the United States. ExxonMobil, Hess and Marathon are all there. Right now, the U.S. imports up to 100,000 barrels of oil a day from Equatorial Guinea, or about a quarter of the country’s oil production.

Oil money gives the country the means to be a model for development and human rights. The economy is nearly 130 times as big as it was when oil was discovered in 1995. But as a report released by Human Rights Watch today details, the government has squandered or stolen much of the money at the expense of its people.

It is a sad contrast, since the country has a per capita income comparable to Spain’s or Italy’s and development indicators more like Afghanistan’s. For just one sad example, infant and child mortality actually has increased — from an already-dismal 103 deaths per thousand in 1990 to 124 per thousand in 2007. Similarly, under-5 mortality rates increased from 170 per thousand in 1990 to 206 per thousand in 2007.

The president and his family are doing just fine, though. They lead lavish lifestyles while most people live in crushing poverty.

A series of corruption scandals involving government officials and their families will give you some idea of how bad it is.

In 2004, a U.S. Senate investigation into the country’s dealings with the now-defunct Riggs Bank detailed how President Teodoro Obiang Nguema Mbasogo used the country’s oil wealth to finance numerous personal transactions, including spending $3.8 million to buy two mansions in a suburb of Washington, D.C. That investigation led to one of the largest fines against a bank in U.S. history, and ultimately the bank’s takeover.

Obiang’s eldest son, Teodorin, bought a $35 million property in California in 2006. In 2004, he spent about $8.45 million for mansions and luxury cars in South Africa. His only known income was a $4,000 monthly salary as a government minister. His $43.45 million in spending on his lavish lifestyle from 2004 to 2006 was more than the $43 million the government spent on education in 2005.

The people of Equatorial Guinea have no way to hold their government accountable. Obiang has been in power since 1979, when he deposed his uncle in a coup. The government severely curtails press freedom and independent civil society, and the political opposition is weak and faces constant government harassment, intimidation, and arrests. In the most recent parliamentary elections in May 2008, Obiang and his allies won 99 out of 100 seats.

The government has joined the Extractive Industries Transparency Initiative (EITI), an effort to make natural resources benefit everyone by setting a global standard for openness in oil, gas, and mining. However, the government has been very slow to implement the initiative’s standards. The danger is that EITI may give the government a veneer of legitimacy even while it stifles its critics and opposes real scrutiny.

Perhaps the best prospect for reform lies with the Obama administration since most of the investment in Equatorial Guinea’s oil comes the US. There are in fact things the administration can do now to break the cycle of corruption in a place like Equatorial Guinea. It should hold the government accountable for human rights and insist that it rigorously enforce anti-corruption laws. Under the Bush administration, that did not happen.

The same month in 2006 that Obiang’s son bought a $35 million Malibu mansion, Secretary of State Condoleezza Rice met with Obiang in Washington and called him “a good friend” at a news conference.

Unless the Obama administration makes it clear to Equatorial Guinea’s leaders that they must share the oil wealth with the country’s people , the human cost of the oil that the US imports from that country will continue to be staggering.

-Ben Amunwa is a campaigner with oil industry watchdog Platform, where he runs Remember Saro-Wiwa, a project that uses art and activism to raise awareness about the impact of the oil in the Niger Delta. The opinions expressed are his own.-

When the news broke of a settlement in the Wiwa v Shell case, a cacophony of responses soon flooded my inbox. Hailed as a victory for human rights by some, others felt disappointed that Shell could throw money in the face of justice. In such a high profile and emotive legal battle, holding oil giant Shell responsible for human rights abuses in Nigeria, including the execution of charismatic activist Ken Saro-Wiwa, hopes were inevitably high.

A settlement was always going to stir some controversy. Activists wanted to see Shell on trial for aiding and abetting the Nigerian military in crackdowns on the Ogoni people in the 1990s. Myself and many others travelled to New York expecting a trial, but came home empty-handed. Yet none of us had spent hours locked in settlement negotiations, nor lived with the burden of a 12-year litigation, not to mention the personal trauma of losing our loved ones to brutal violence. There is a growing consensus that the settlement is a victory in favor of the plaintiffs, and a step forward on the long road to corporate accountability.

Eager to flex its public-relations muscles, Shell claimed they agreed to a settlement for “compassionate” reasons. A statement on Tuesday said:

“Shell today agreed to settle a court case in New York related to allegations in connection with the Nigerian military government’s execution of Ken Saro-Wiwa and others in 1995, making a humanitarian gesture to set up a trust fund to benefit the Ogoni people…Shell has always maintained the allegations were false… we were prepared to go to court to clear our name.”

In spite of Shell’s official denials, all the signs point towards complicity. No multinational company settles out of court for $15.5 million due to “humanitarian” or “compassionate” impulses. According to attorneys, this payout is far higher than similar cases.

The real reason why Shell settled is because the evidence compiled by the plaintiffs, was damning enough to force an out of court settlement. Far from being willing to defend itself before a jury, Shell has spent the last 12 years fighting to stay out of the courtroom, and to keep the evidence out of the public eye. If Shell was innocent of any wrongdoing, why didn’t they tough it out in court?

For the plaintiffs, the prospect of an appeals process adding another 4 years to the litigation, and the fact that they could only expect monetary damages anyway made a settlement worthwhile.

The grievances of local people in the Niger Delta, and the injustices that Ken Saro-Wiwa fought against are far from settled with this case. Campaigners will now be publicising the evidence gathered by lawyers about Shell’s partnership with Nigerian military, until the company comes clean about its role in the violence.

If Shell has any genuine concern for the dignity of the Ogoni people, or other communities in the Niger Delta, it would put an end to the daily environmental devastation caused by gas flares and oil spills. These practices have poisoned communities and choked livelihoods for as long as Shell has been producing oil. This daily abuse of human dignity and rights shows just how much more needs to be done before justice is served in the Niger Delta.

The Wiwa case was always about the claims of 10 individuals, and it is the first victory in what we hope will be a long line of cases that hold corporations to account for violations of international law.

– Neil Collins is a Reuters columnist. The opinions expressed are his own –

LONDON, April 8 (Reuters) - BP has undergone a critical period of self-assessment over the last four years. The chairman, no less, says so in the oil company’s annual report.

Peter Sutherland’s assertion might be tested at next week’s annual meeting, following the departure from the board of Tom McKillop as penance for being caught in the chair when Royal Bank of Scotland collapsed.

Big companies can rise above such isolated setbacks, but BP seems particularly prone to them. Just when it seemed that the change of chairman was going to be unusually smooth, the knives came out for Paul Skinner, and his transfer from Rio Tinto was off. Sutherland promised not to stay on for more than another year, and pledged to “refresh” the board.

Someone needs to. The chief financial officer, Byron Grote, is coming up for retirement, while Erroll Davis, a non-executive, has been on the board since 1997. The deputy chairman, Ian Prosser, has been there since 1998.

Prosser, it should be recalled, is the brewer whom the J Sainsbury board anointed as its chairman in 2004 only for him to have to withdraw after the idea received a raspberry in the press. Prosser is unlikely to seek re-election to the board next year.

Tony Hayward, who stepped up to chief executive after John Browne was obliged to resign in 2007, has enough problems without having to look over his shoulder at an unfamiliar board.

The good news is that the highly-regarded Bob Dudley, now extracted from the Russian glue-pot marked TNK, joins the board at next week’s meeting.

Sutherland, in his statement, says BP is now “weighing shareholder returns towards dividends”, rather than share buybacks, but with oil under $60 a barrel, BP does not generate enough cash to cover the current payout.

Last year’s oil boom encouraged all companies in the sector to commit more to exploration and production, and BP’s gearing could rise from around 20 percent now to nearer 30 percent, which is at the high end for an oil major.

BP shares remain a highly-geared play on the oil price, and a new board being up to the task. After all, “the world economy depends on our efforts” according to Sutherland. No trace of hubris there, then.

(Editing by Richard Hubbard)

-- John Kemp is a Reuters columnist.  The views expressed are his own --

The record differential between the front-month and more liquid second-month contracts at expiry last week once again raised pointed questions about whether the NYMEX light sweet contract is serving as a good benchmark for the global oil market, or sending misleading signals about the state of supply and demand.

The expiring January 2009 contract ended down $2.35 on Friday at $33.87, while the more liquid February contract actually rose 69 cents to settle at $42.36 - an unprecedented contango from one month to the next of $8.49.

Criticism of the contract is not new, and past calls for reform have been successfully sidelined. But with policymakers taking a keener interest as a result of wild gyrations in oil prices this year, and a continued focus on regulatory changes to improve market functioning in future, there is at least a chance changes will be adopted as part of a wider package of futures market adjustments.

AN UNREPRESENTATIVE PRICE

During the surge to $147 per barrel earlier this year, OPEC repeatedly criticized the NYMEX reference price for overstating the real degree of tightness in the physical market and causing prices to overshoot on the upside.

While rallying NYMEX prices seemed to point to an acute physical shortage and need for more oil, Saudi Arabia could not find buyers for the 200,000 barrels per day (bpd) of extra oil promised to U.N. Secretary-General Ban Ki-moon or the 300,000 bpd promised to U.S. President George Bush in June.

Bizarrely, rather than acknowledge there was something wrong with the reference price, some market participants suggested Saudi Arabia should increase the already large discounts for its physical crude to achieve sales in a market that clearly did not need the oil, and was not paying enough contango to make storing it economic (contango is where the futures price is above the spot market).

The NYMEX WTI price may have achieved unprecedented media fame as a result of the "super-spike", but a futures price to which producers and consumers were paying ever larger discounts for actual barrels was clearly not a good indication of where the market as a whole was trading.

Now the market risks overshooting in the other direction. Intense pressure on the front month in recent weeks has more to do with the contract's peculiarities (in particular storage restrictions at the delivery point) than a further deterioration in oil demand or a market vote of no-confidence in the 2.2 million barrels per day further cut in oil production announced by OPEC at the end of last week.

The collapse in NYMEX prices nearby risks exaggerating the real degree of oversupply  and demand destruction, sending the wrong signal to producers and consumers about the wider availability of crude in the petroleum economy.

DOMESTIC PRICE, GLOBAL BENCHMARK

The NYMEX contract is for a very special type of crude oil (light sweet) delivered at a very special location (Cushing, Oklahoma) in the interior of the United States. It is not representative of the majority of crude oil traded internationally (most of which is heavier and sourer) and delivered by ocean-going tankers.

These specifications made sense when the contract was introduced as a benchmark for the U.S. domestic market.

U.S. refiners have a strong preference for light oils, for which they were prepared to pay a premium, because of their much higher yield to gasoline. The inland delivery location, centrally located and near the main Texas oilfields, rather than one on the coast, made sense for a contract that tried to capture the "typical" base price for crude oil paid by refiners across the continental United States.

But these specifications make much less sense now the NYMEX price is increasingly used a benchmark for the global petroleum economy, in which light sweet crudes are only a small fraction of total output. Just as NYMEX prices sent the wrong signals about physical oil availability on the way up, distorting the market and triggering more demand destruction than was really necessary, they now risk sending the wrong ones on the way down.

Earlier this year, the problem was a relative shortage of light sweet crude oils at Cushing, while all the extra barrels being offered to the market by Saudi Arabia were heavier, sourer crudes that could not be delivered against the contract. Moreover, extra Saudi crudes would have arrived by ship, and the pipeline and storage configurations around Cushing would have made it difficult to deliver them quickly against the contract.

Financial speculators were able to push NYMEX higher safe in the knowledge Saudi Arabia could not take the other side and overwhelm them by delivering physical barrels to bring prices down. The resulting spike exhibited all the characteristics of a technical squeeze:  tight contract specifications ensured there could be shortage of NYMEX light sweet inland oils even while the global market was oversupplied by heavier, sourer seaborne ones.

Now the opposite problem is occurring. Crude stocks at Cushing have doubled from 14.3 million barrels to 27.5 million since mid-October. Stocks around the delivery point are at a near-record levels and approaching the maximum capacity of local tank and pipeline facilities (https://customers.reuters.com/d/graphics/CUSHING.pdf).

As a result, the market has been forced into a huge contango as storage becomes increasingly expensive and difficult to obtain, ensuring the expiring futures trade at a substantial discount.

But Cushing inventories are not typical of the rest of the U.S. Midwest (https://customers.reuters.com/d/graphics/PADD2_EX_CUSHING.pdf) or along the U.S. Gulf Coast (https://customers.reuters.com/d/graphics/PADD3.pdf), where stock levels are high relative to demand but nowhere near as overfull as in Oklahoma.

Once again the problem is geography. Coastal refiners have responded to the downturn by cutting imports of seaborne crude, limiting the stock build. But the inland market is the destination for some Canadian crudes that have nowhere else to go, and the pipeline configuration means they cannot be trans-shipped to other locations readily.

Light sweet crude has been piling up in the region, with refiners choosing to deliver the unwanted excess to the market by delivering it into Cushing.

NEW GRADES, NEW DELIVERY POINTS

The easiest way to make NYMEX more representative would be to widen the number of crude grades that can be delivered, and open a new delivery point along the U.S. Gulf Coast. Both reforms would link the contract more tightly into the global petroleum economy.

NYMEX already permits some flexibility in delivery grades. Sellers can deliver UK Brent and Norwegian Oseberg at small fixed discounts to the settlement price, and Nigerian Bonny Light and Qua Iboe, as well as Colombia's Cusiana at small premiums.

In principle, there is no reason the contract cannot be modified further to allow a wider range of foreign oils to be delivered at larger discounts to the settlement price.

More importantly, NYMEX could open a second delivery location along the Gulf Coast, increasing the amount of storage capacity available, and linking it more closely into the tanker market.

If prices spiked again, a coastal delivery location would make it much easier for Saudi Arabia to short the market and deliver its own barrels into the rally. By widening the physical basis, it would also make it easier to support the market by cutting international production and avert a glut trapped around the delivery location.

So far, the market has continued to resist change. But there are signs policymakers might enforce one.

Earlier in the year, Saudi Arabia strongly hinted western governments should look at reforming their own futures markets rather than call for production of even more barrels of oil that could not be sold at the prevailing (unrealistic) price.

Naturally, some of the reform impetus has ebbed along with prices and demand. But policymakers continue to show interest in structural reforms, as was evident at last week's London Energy Meeting, and there is an increased willingness to challenge unfettered market dynamics.

It is still possible the incoming Obama administration might force contract changes as part of a wider package of reforms designed to improve the functioning of commodity markets, reduce volatility and send clearer, more consistent price signals to the industry and consumers.

For previous columns by John Kemp, click here.

The Organisation of the Petroleum Exporting Countries agreed on Wednesday to make its deepest output cut ever to counter slumping demand and falling oil prices.  The output cut has been received with cautious optimism by analysts.

Some say that the price of oil will fall further, while others say $40 a barrel was the lowest it will go. "If you look at the market, prices are going up immediately," said Frank Schallenberger, head of commodity research at Landesbank. "I really think this is the end of a bear market. $40 was the bottom."

However, the White House called to the historic cut "short-sighted" and said the oil cartel has an obligation to keep the market well-supplied. "It's not clear that OPEC's actions will be effective given the shift in global demand and the ability of OPEC members to meet the cartel's targets," White House spokesman Tony Fratto said.

Will the price of oil continue to drop or will it recover? And how will the oil supply cut trickle down to the consumer in terms of cost?

Andrew Simms is policy director and head of the climate change programme at the London-based New Economics Foundation. The opinions expressed are his own.

Nothing reveals the thin veneer of civilisation like a threat to its fuel or food supply, or the cracks in society like a major climate-related disaster. But that, increasingly, is what we face: the global peak and decline of oil production; and a global food chain in crisis due to multiple stresses including imminent, potentially irreversible global warming.

The vulnerability of our system was revealed in the year 2000 when fuel protests in the UK disrupted food supplies and left the nation just, “nine meals from anarchy.” At the time, the government were able to force the restoration of fuel supplies. That was a short-term protest, but what if it’s the ground itself protesting that there is no longer enough oil to go around?

The International Energy Agency (IEA) said of world oil production that there will be, “a narrowing of spare capacity to minimal levels by 2013,”making, “significant downward revisions” from the previous year. Economic and social impacts from such a market shock could be even faster, deeper and more global than any banking crisis. They could also be potentially irreversible.

The IEA’s motto is, “energy security, growth and sustainability,” which is fine, except that there doesn’t appear to be any. Our food system depends on oil not just for transport, but also for chemical inputs without which intensive farming would fail. The UK lost its “energy independence” in 2004, and our reliance on external supplies, the subject of hotly competing interests, is steadily growing.

In Britain, until the early 1990s secret food stocks of easily stored basics like biscuits and flour were held officially. Now, the government depends on the retailers whose vulnerable distribution networks are built around “just-in-time” delivery. But the supermarkets have undermined the resilience of our food chain equally by presiding over the hollowing-out of its infrastructure, in terms of the number, diversity and independence of producers, suppliers, and services.

On top of that is our collective de-skilling with regard to the preparation and storage of food. These are all things essential to resilience in the face of external shocks. Against this backdrop, our national food self-sufficiency is in long-term decline. It has fallen by over one fifth since 1995. So, we are increasingly dependent on imports at precisely the time when, for several reasons to do with climate, energy, economics and changing consumption patterns, the guarantee of the rest of the world’s ability to provide for us is weakening.

In April this year, 37 countries faced a food crisis due to a mix of climate-related, conflict and economic problems. From Haiti to Egypt, India and Burkina Faso there was rioting in the streets. Stocks of rice, on which half the world depends, were at their lowest level since the 1970s. Around the same time, U.S. wheat stocks were forecast to drop to their lowest levels since 1948.

The fabric of the food chain is wearing thin. Energy issues, global warming and energy-intensive eating habits are now poking holes through it. For example, intensive farming’s big weak point is its dependence on fossil fuels to defy ecological gravity. As much a contributor to climate change, farming is uniquely and immediately vulnerable to warming. Against the background of terrifying long-term projections for global drought from the UK’s Hadley Centre, a single extreme weather event can tip any season’s global food cart.

Our approach to natural resources is more related than we realise to the catastrophic creation of unsustainable levels of financial credit. The latter, for example, helped finance the over-consumption of the former. And, the idea that we can have limitlessly rising resource consumption is even more dangerous than the illusion, now shattered, that credit can be extended without end.

At an international level, to reinforce social and environmental resilience, a massive transformation of our energy, transport, food and construction systems is needed that also compresses global income inequality, raising the incomes of the poor and lowering the consumption of the rich. Roosevelt’s original new deal brought stability, developed new infrastructure and radically reduced income inequality. A green new deal for environmental transformation today could do the same.

To prevent chaos in the face of external shocks, we need an economic system that builds strong human and communal relationships and steers us towards living within our environmental means. Recession, fuel and food and fuel prices are spurring a dramatic growth of vegetable gardening and urban agriculture. Elsewhere, Transition Towns are attempting to break our carbon chains, and, through diversity and decentralisation, strengthen the nation’s community and economic fabric. A sort of cultural self-medication is happening. Environment Secretary Hilary Benn has begun alerting government to the scale of the problem — the challenge now is to ensure that government policies don’t, through out-dated market-obsessed economic thinking inadvertently increase the nation’s vulnerability, rather than strengthening our resilience.

John Kemp is a Reuters columnist. The views expressed are his own.

LONDON, Dec 8 (Reuters) - China's decision on Friday to link domestic fuel prices to the international price of crude oil, but increase consumption taxes on gasoline and diesel sharply to spur more efficient use of energy in the medium term, raises the question whether the incoming Obama administration might be tempted to do the same.

China is taking advantage of a cyclical pull back in energy to push through a permanent structural increase in taxes and prices. The aim is to combine a short-term boost to the economy with longer-term and more consistent incentives for improving energy efficiency.

By consolidating a series of tolls and administrative charges into a single, easy to collect consumption tax, the government is simplifying the tax system, creating a new source of revenue, and ensuring the change will have no impact on the politically sensitive inflation rate.

More importantly, it creates a fairly simple mechanism for raising energy costs further in future to spur additional efficiency gains, irrespective of cyclical changes in the crude oil price.

Once short-term economic weakness is past, the government can easily raise the consumption tax progressively over the next few years.

In effect, the tax breaks the link between the government's energy efficiency programme and short-term oil-market movements.

NEW ADMINISTRATION PRIORITIES

Across the Pacific, the incoming Obama administration has made clear improving energy efficiency is also one of its highest priorities.

The president-elect's future national security adviser, General James L. Jones, has been working on energy issues for an affiliate of the U.S. Chamber of Commerce since retiring as NATO's supreme allied commander in Europe. He made clear in a recent interview improving energy security would be one of his central objectives, marking an unusual extension of the adviser's traditional role.

The incoming administration faces several related challenges, however:

• It needs to maintain the recent trend towards smaller and more fuel efficient motor vehicles, even though retail gasoline prices have halved in less than six months.
• It needs to find a way to increase the volume of ethanol blended in the gasoline supply, even though ethanol is now more expensive than fossil-fuel gasoline, and mandated volumes are running up against the technical limits of the U.S. car fleet (the "blending wall").
• And it needs to find a way to continue providing incentives for developing alternative energies (such as advanced biofuels and oilsands) as well as alternative power sources (fuel cells, electric vehicles).

VOLATILITY DEGRADES PRICE SIGNAL

The common problem is that short-term price volatility threatens long-term strategic planning by both energy producers and consumers.

Adam Smith's theory of the "invisible hand" has price changes acting as a signal to ration demand and encourage supply.

Policymakers have long accepted that inflation can interfere with these signals by making it hard for consumers and producers to distinguish between a relative change in prices and incomes (to which they should respond) and a general rise in the price and income level (to which they should not).
Inflation introduces "noise" into the price mechanism, making it hard to extract signals correctly.

Extreme price volatility can have the same impact. Large price movements and repeated price reversals leave producers and consumers uncertain about the correct response.

The problem is worse in sectors such as energy where changes in consumption and production involve long-time lags and costly investment.

The oil price surge in 2006-2008 was widely interpreted as a response to the threat of a long-term shortfall in supply (since there was no actual shortage of physical crude oil in the near term). It appeared to send a strong signal about the need to develop substantial new oil reserves, invest heavily in alternative fuels, and achieve massive increases in energy efficiency.

The subsequent collapse, including long-dated prices, seems to be signalling that these long-term high-cost investments will not be needed.

Producers and consumers are struggling to work out whether the market was right in JulY 2008; whether it is right now; or whether the world really has changed that much in less than six months.

A HELPING HAND FOR ADAM SMITH?

The incoming administration's public announcements indicate senior policymakers believe all these new and alternative fuel supplies will be needed. The question is how to maintain the efficiency drive and incentives for long-term investment during a period of price weakness.

Following China's example and raising fuel taxes is probably the most attractive mechanism.

By raising the long-term floor for domestic gasoline and diesel for any given level of international crude prices, it sharpens efficiency incentives and would maintain the pressure towards smaller and more fuel efficient vehicles.

Crucially, it could solve the problem of the blending wall. Most U.S. vehicles are able to run on a maximum 90-10 gasoline-ethanol blend (E10) that will limit the overall amount of ethanol blended into the fuel supply to around 12-13 billion gallons per year, and is likely to become binding in the next 18 months.

To meet the longer-term objective of blending as much as 36 billion gallons into the fuel supply by 2022, the administration will need to increase the number of vehicles taking higher 15-25 percent blends, or shift an increasing proportion of the car fleet to flexible-fuel vehicles running on a 15-85 gasoline-ethanol blend (E85).

The problem for policymakers is whether to go for a big-bang approach (pushing for widespread adoption of E85-adapted vehicles) or a gradualist one (increasing the standard blend to 15 percent, then 20 percent, etc).
Widespread adoption of E85 requires investments in an expensive pipeline infrastructure and new cars.

Neither is likely unless distributors, pipeline companies and motor manufacturers can be guaranteed sufficient minimum demand for the fuel and associated cars.

The question is how to promote widespread adoption of higher 15-20 percent fuel blends and E85. One possibility is to make production of E85 vehicles a condition of any government rescue package for the major auto makers.

But rolling out E85 vehicles does not guarantee they will actually be filled up using E85 fuel. Federal agencies have been obliged to buy E85-capable vehicles since the early 1990s. Most are filled up with regular gasoline, owing to the lack of filling stations carrying E85 in most areas outside the Midwest. And at low gasoline prices, there is no guarantee ethanol will be competitive.

There must be a temptation to impose a sharply differential tax rate on the fossil fuel and ethanol components of gasoline to encourage higher blend rates or E85 vehicles, creating clear long-term incentives for switching to more ethanol use.

The main factor restraining policymakers is fear of advocating any tax increases at a time when households are struggling with mortgage payments and falling employment.

But the big pull back has created some headroom to raise tax rates and long-term energy costs while still allowing pump prices to fall in the short term.

Raising fuel taxes will therefore be a very tempting option for the new administration. It could be presented as part of an integrated energy efficiency, climate change and national security strategy, raising useful revenues to pay for some of the massive stimulus and speed the return to fiscal discipline in the medium term.

The question is less whether fuel taxes will rise substantially, but when.