. . . more than half the world's oil lies in countries that exercise excessive state control. . . Governments dominate Middle East oil production, with countries fully owning the industry or allowing only minority partners from the private sector.

Two-thirds of the oil reserves are in nations Heritage rates as mostly unfree or worse on government intervention. Adding Iraq, a nation with a history of state control, the proportion climbs above three-quarters.

Although today's prices give private companies incentives to drill for oil, government ministries don't always take full advantage of market opportunities. They may be mired in red tape. They may treat the oil industry as a cash cow, choosing to rake in revenue without incurring the costs of investing in new capacity. They may prefer to reap the gains of monopoly prices. . . .Saudi Arabia, for instance, maintained a relatively constant capacity to produce oil from 1994 to 2001. It has increased its capacity only a little over the past five years. Mexico has considered inviting foreign investment into its energy sector, but government- owned Pemex retains control and has done little to expand capacity. . . .

A large part of the world's oil reserves are outside the easy reach of free markets, with their incentives and disciplines. Oil prices are rising—not because the world is running out of oil but because the bulk of reserves are in countries where market incentives cannot work fully or in the hands of monopolists who may be exercising their power by restraining investment.

Because of the mismatch between reserves and economic systems, today's oil prices are higher than they would be in a world of free markets. Tomorrow's oil prices are likely to be higher, too, because producers, divorced from market incentives or with an incentive to restrain production, are likely to underinvest in new capacity.

Venezuela is one vivid example of where state control is worsening.