By Robinson Meyer
In the past few months, Democrats have rediscovered one of the oldest ideas in politics: Nobody likes when prices go up.
In January, inflation rose faster than it has in almost 40 years. But not all prices are rising evenly. Oil is playing an outsize role in the surge. Gasoline and jet-fuel prices have reached their highest levels since 2014. Rising oil prices alone can account for nearly 30 percent of the “excess” inflation that the United States has seen since the pandemic began, according to the financial journalist Matthew C. Klein.
Unsurprisingly, these statistics are bad news for the White House. The ups and downs of President Joe Biden’s disapproval rating track almost precisely the rise and fall of prices at the pump. Gasoline is, after all, the ur-commodity, the only product whose prices are advertised on big signs by the side of the highway. But these numbers undercount the extent of the woe. When fossil fuels get expensive, their rising costs can propagate through the rest of the economy. In the past few months, companies have complained that high oil and natural-gas prices are raising the cost of shipping goods (because trucks, ships, and planes burn oil-derived fuels), packaging them (because plastic uses crude oil as a chemical feedstock), and even growing new food (because fertilizer is made with natural gas). Some of these higher costs ultimately flow to consumers as rising prices.
2. The Structure Theory
For more than a century, the oil market has been split into two categories.
Some oil drillers produce as much oil as they can, as fast as they can. For financial or geological reasons, these smaller drillers don’t have the ability to increase or decrease their oil flow. As long as they’re turning a profit, they pump oil and then they sell it. But a few companies or countries can form a cartel and sit on so much oil that they have what’s called “spare capacity,” which is the ability to produce more oil at will at any time. By turning their oil faucet all the way on, this spare producer can flood the market with so much oil that other drillers struggle or go out of business. By turning it off, they send oil prices soaring.
In other words, in the oil business, “spare capacity” is what bestows market power on companies and gives them the ability to set prices.
Cut to 2019, when the global oil market looked like it never had before. The United States had defied expectations to become the world’s top oil driller, producing 20 percent of global supplies. OPEC Plus, a cartel of the mostly Middle Eastern OPEC countries plus Russia, claimed roughly 40 percent of the market.
The U.S. and OPEC Plus could not have worked more differently. In the most important OPEC countries, a few large facilities operated by state-owned monopolies dominated oil production, pumping millions of barrels of oil a day out of vast underground oceans of oil. They have historically wielded “spare capacity.” In the U.S., hundreds of private companies operated thousands of small fracking wells from Texas to North Dakota, embodying the “pump all the oil you have” strategy. These fracking companies were flooding the market with cheap oil by unlocking hidden reserves locked in shale deep underground, crowding out the OPEC countries from their traditional cartel role. But there were so many of these shale companies that most were losing money.
Then the pandemic hit. People stopped driving and flying. Oil demand crashed worldwide—and the fracking companies collapsed. The U.S. shale industry consolidated, shrinking the number of shale companies from the hundreds to the dozens, Emerson told me.
That was when OPEC Plus saw its window, Samuel Ori, the director of the University of Chicago Energy Policy Institute, told me. (Disclosure: I used to be a paid journalism fellow at the institute.) As the recovery began, OPEC Plus pumped less oil than the world demanded, even though it had the capacity to pump more. This spare capacity reclaimed the cartel’s market power—and allowed global oil prices to get “as high as is bearable,” Ori said. Meanwhile, the U.S. shale industry is now so consolidated and so desperate to deliver profits to Wall Street that it hasn’t started drilling new wells again. U.S. oil output is still below its pre-pandemic level.