Even in times like these, free markets are the best system.
Hard times indeed are hard, and that adjective is wholly inadequate to describe the double whammy now afflicting U.S. crude-oil producers: declining demand due to the COVID-19 pandemic and the large increase in overseas production attendant upon the flood-the-market tug-of-war between the Russians and the Saudis. As a result, the domestic price of crude oil (West Texas Intermediate) has nosedived from $63.27 per barrel on January 6 to $21.51 on March 27, a decline of 66 percent.
And so it is unsurprising that some public officials are trying to find ways to ease the pain. Ryan Sitton, a member of the Texas Railroad Commission (which has regulatory authority over oil and gas production in the state), has proposed a 10 percent cut in Texas oil output in coordination with Russia and Saudi Arabia doing the same, as a means of propping up prices. That is a proposal for an explicit cartelization of the domestic and world oil markets. At the same time, several U.S. senators, led by James Inhofe (R., Okla.), now are arguing in favor of a “dumping” investigation of Russian and Saudi oil sales as a means of preserving U.S. “energy independence,” a rather ironic orientation given the effects of the U.S. fracking revolution on international oil and gas prices.
A 10 percent cut in Texas oil production would amount to about half a million barrels per day (mbd), 4 percent of total U.S. output of about 12.5 mbd. Any resulting price increase would elicit an increase in foreign oil exports to the U.S., thus eroding the intended price effect, a self-defeating outcome. The recent experience with just such a production cut in Alberta does not bode well for the success of a similar policy. Were the U.S. to impose a tariff, the revenues would be spent, creating interest groups that would demand that the tariff not end. If instead a quota limitation were imposed on U.S. imports of foreign oil, the market distortions and regulatory complications would be enormous, as was the case during the 1959–1973 U.S. quotas on oil imports. Have we forgotten the Brownsville U-turn?
And about that coordination with the Russians and Saudis: Precisely how would their promises of reduced output and higher prices be enforced? The ways that prices can be shaved without formally cutting them are numerous: More-lenient credit or payment terms, higher-quality blends of oil delivered at the benchmark price, rebates in the form of foreign aid or subsidized sales of other goods and services, and on and on. And even if the Russians and Saudis were to keep their production and price promises, it is easy to predict that other producers will find ways to increase their sales in the global oil market. Will the U.S. send in the Marines? Obviously not, but the precise means with which any such agreement would be enforced are far from clear.
Government meddling in the oil market, whether at the federal or the state level, inexorably will prop up less efficient producers — the ones most in trouble due to low prices — and make it more difficult for the more-efficient ones to take advantage of their greater efficiency in the face of adverse market conditions. This outcome is inevitable: Production cuts would have to be coordinated or imposed, and political considerations would overwhelm efficiency objectives. Traditionally, we have supported greater market efficiency as a means of conserving the use of scarce resources and thus increasing the size of the aggregate economy, a sound argument that will be more difficult to defend once we resort to market manipulation as a means of addressing adverse movements in market prices for crude oil.
Such explicit market manipulation in coordination with the Russians and Saudis does not bode well for future U.S. arguments in favor of allowing international markets to work. Moreover, governments, whether at the federal or the state level, are not in the habit of handing out favors for free. The longstanding assertions of “subsidies for the oil industry” — virtually none of those policies actually are “subsidies” — will be far more difficult to refute once such real subsidies as cartelization and retaliation for “dumping” are implemented. It will become vastly more problematic to argue against renewables subsidies and green new deals — and mindless regulatory costs imposed on oil and gas operations — and other such massive distortionary policies.
It may be the case that the proponents of such market meddling view the proposed government interventions as temporary, to be maintained only until prices return to something approximating “normal” when the pandemic subsides and the Russians and Saudis find an accommodation. Apart from the reality that such policies create interest groups demanding that they be preserved — notice that subsidies for wind and solar power have returned from the dead time and again — the assumption that prices will recover is far more problematic than many assume. Crude oil is a natural resource that can be consumed today or tomorrow; it is “substitutable” over time. This means that the price today is the best market evaluation of the price tomorrow; if a sharp price increase is expected tomorrow, the price would rise today.
Accordingly, it might be the case that those predicting a price recovery relatively soon will be proven correct, but any expectation that exceptionally low prices now will rise sharply (that is, faster than the rate of interest) over the foreseeable future, thus allowing the cartelization and dumping policies to end, is a problematic strategy. That is not what market prices are telling us, and market prices by far are the best parameter incorporating all available information.
Senator Inhofe and his senatorial allies justify their request for a “dumping” investigation on grounds of “energy independence.” The public discussion of that topic is nothing if not confused: However counterintuitive it may seem, the degree of “dependence” on foreign sources of energy is irrelevant, except in the case in which a foreign supplier or foreign power can impose a physical supply restriction, perhaps through a naval blockade or a military threat to ocean transport through, say, a narrow strait. Because the market for crude oil is international in nature, nations that import all of their oil (e.g. Japan) pay the same prices as those that import none of their oil (e.g. the U.K.). A change in the international price of oil, caused perhaps by a supply disruption, yields price changes in the import-dependent and import-independent economies that are equal, except for such minor factors as differences in exchange-rate effects. That is why “embargoes” — an attempt to impose a higher price on some subset of the market — do not work. In 1973, the embargo had no effect at all, but the Arab OPEC production cut increased prices for all nations, and the U.S. system of price and allocation controls yielded queues and market chaos. There was no embargo in 1979, but there was a production cut attendant upon the overthrow of the shah of Iran, a significant price increase, and, again, market chaos in the U.S. caused by the imposition of price and allocation controls.
It is important to observe that central players in the U.S. oil/gas sector oppose these proposals, arguing explicitly that market forces should be allowed to work. One example is the CEO of the American Petroleum Institute, who argues that “we have always supported the market to be an arbiter of the price of oil and gas, and during times of crisis it is not appropriate to abandon those principles.” The cartelization and dumping proposals would make it much more difficult to criticize market machinations by OPEC in the future, by actually making the U.S. an implicit member of OPEC. Is that a serious policy?