Crude oil prices have been battered by both an unprecedented decrease in global oil demand stemming from the COVID-19 pandemic and the outbreak of a price war between Saudi Arabia and Russia, the two largest producers in the OPEC+ global oil cartel. The U.S. benchmark West Texas Intermediate price of crude oil has fallen from $52 per barrel on February 1 to $20 per barrel as of March 30. The last time crude oil was this cheap was the aftermath of the September 11, 2001 terror attacks.
The oil price crash has been nothing short of a disaster for U.S. crude oil producers, many of whom were having a tough time making a go of it even when oil sold for $50 a barrel. Drilling a new shale oil well was a difficult but certainly not impossible way to make money then; it’s a sure-fire loser now. So we should expect new oil well drilling and recompletions to come to a nearly complete halt within the next couple of months. A production decline, layoffs of workers, and bankruptcies will quickly follow.
So what should be done? Prominent voices have argued that the United States needs to aggressively encourage the OPEC+ price war to end in order to save the industry. President Trump himself has made no secret of his desire that Saudi Arabia and Russia get back to their collusive ways. Some, including Texas Railroad Commissioner Ryan Sitton and some (but not all) major shale oil producers, have argued yet one step further: Texas should join in on the cartel by agreeing to impose production quotas on firms in the state, with perhaps the U.S. federal government playing a coordinating role.
These ideas are terrible for U.S. and global oil consumers, will do next to nothing to help oil industry workers, and will set a bad precedent. We should be celebrating OPEC’s price war rather than trying to end it.
Suppose that Saudi Arabia and Russia agree to end their price war and cut production by a few million barrels per day. The price of oil will then rise – by how much will depend on how much supply is taken off the market – and every dollar per barrel increase will lead to an increase in what Americans pay at the pump. Before the pandemic, the United States used about 20 million barrels of petroleum products per day. Even if U.S. oil demand falls by 25%, every $1 per barrel increase in the price of oil will mean that U.S. consumers must shell out an additional $15 million every single day, at a time when many are struggling to get by on reduced or disappearing incomes.
The cost is worse on a global scale. Pre-pandemic, world oil consumption was roughly 100 million barrels per day. So even after a 25% demand reduction, that’s a cost of $75 million per day for every dollar per barrel increase in oil prices. Many of the countries that are large oil consumers are also major U.S. trading partners – e.g., European countries, China, and Japan – so their losses will spill over to us. Others are low-income countries that can ill afford even modest increases in commodity prices while they fight the virus itself.
There are two sides of every coin, and the losses suffered by oil consumers will be recouped (mostly, but not entirely) by oil producers. About half of world oil production (as of 2018) came from the OPEC countries together with Russia, so a large share of the money will flow there. But what about benefits to U.S. oil producers? Sure, producers will benefit, but let’s be clear-eyed about who the beneficiaries will be. Jacking up the price of oil will help firms and royalty owners make more money off production from wells that were already drilled. That won’t give oil producers any incentive to retain employees. The shutdown of drilling activity will result in widespread industry layoffs regardless.
To sum up: a successful effort aimed at encouraging Saudi Arabia and Russia to collude will transfer wealth from U.S. and world oil consumers to: (1) Saudi Arabia and Russia; (2) other OPEC net oil exporters; (3) private oil company shareholders and debtholders; and (4) landowners receiving royalty checks. I would much rather let consumers keep their money by letting them enjoy the benefits of actual competition in the world oil market.
If we want to help workers in distressed industries – like the U.S. shale oil industry – we have explicit policy tools at our disposal. Indeed, the recent stimulus bill includes assistance like direct payments, expanded unemployment insurance, and aid to state and local governments. These measures, unlike manipulating the oil market itself, target aid to where it is most needed without directly harming oil consumers in the middle of the greatest economic crisis of our time.
The potential precedent is also deeply problematic. If we can rationalize joining forces with OPEC to manipulate oil markets now, what stops us from doing so in the future when (hopefully) the COVID-19 crisis is behind us and oil demand returns to normal? Indeed, why stop at oil? Once we appease oil producers, other industries – natural gas, timber, steel, you name it – will queue up on the White House front lawn looking for their cartel licenses too.
Environmental benefits from cutting oil production are yet another poor argument for dragging the United States into a collusive agreement with OPEC. There are better ways to fight climate change than to write billion dollar checks to Saudi Arabia. If we instead price carbon, we can reduce oil use while at the same time generating revenue that we can use to alleviate economic hardship or, even better, invest in technology and supplies targeting COVID-19 itself.
The breakout of competition in the world oil market has been one of the few pieces of good news over what has otherwise been a tragic past month. The last thing we should be doing is encouraging, let alone participating in, a return to oil market collusion and market manipulation.