The crude oil sector now is confronted by a sharp decline in demand conditions caused by the COVID-19 pandemic and an increase in production attendant upon the price feud between Russia and Saudi Arabia. Whether the deal brokered over the weekend by the Trump administration among Mexico, Russia, Saudi Arabia, and the U.S. will raise prices more than trivially and for more than a trivial period is a very open question. In any event, current conditions have yielded massive economic distress and dislocation in the oil patch. It is easy to forget—in particular by those who view the “oil industry” as an abstraction producing only environmental harm—that the economic distress has been inflicted upon far more than only “Big Oil.” Large numbers of actual people and families and communities are suffering, along with a vast array of others dependent upon the fortunes of the oil sector for their retirement security and other important dimensions of their economic wellbeing.
It is therefore unsurprising that public officials closest to those bearing such heavy burdens would be driven to find ways to ease the pain. That their intentions are noble is undeniable, but the same is true for the array of unintended adverse consequences that would ensue were their proposals to be adopted.
The two most prominent such proposals are for a production cut in Texas to be imposed by the Texas Railroad Commission, and for a limitation on imports of crude oil into the U.S., imposed either through a tariff or a direct quota limitation.
A mandated production cut in Texas would have little effect on domestic prices: A cut of 10 percent would amount to half a million barrels per day out of total U.S. production of about 12.5 mbd. The trivial price impact would yield strong pressures to find a way to coordinate such a reduction in output with the Russians and the Saudis. That would be an explicit cartelization of the crude oil industry, which would have two effects. In the shorter term, it would elicit increased output by domestic producers outside Texas and by foreign producers not party to an agreement. It would, therefore, be self-defeating.
In the longer term, official participation by the U.S. in such a cartelization effort would make U.S. support for the market allocation of resources—and the freedom and national wealth yielded by it—much more difficult to defend as a matter of political principle. At a more mundane level, industries harmed by the artificial increase in crude-oil prices will demand that government find a way to shield them from harm, a dynamic process of political favoritism (“rent-seeking”) that has no obvious endpoint.
Let us not forget that it was only a few years ago that the petrochemical producers were lobbying for limits on the export of natural gas, as a tool with which to reduce their input costs. That set of proposals was widely rejected by the natural gas producers and many, many others, on the obvious grounds that it was wholly in conflict with the free-market principles that for the most part underscore the American economy. Once a blatant violation of those principles is implemented in pursuit of higher prices for crude oil, it will prove much more difficult to defend market processes from the demands of such innumerable interests as the refiners and the truckers and the farmers and all those who use energy. Which means: Every conceivable interest group will demand compensation, a sharp upward ratchet on resource allocation by government.
The small price effect of a Texas production cut would strengthen demands for import restrictions, already being promoted by such important political players as Sen. James Inhofe (R-OK). If a tariff is imposed, the revenues will be spent, creating political pressures to make the tariff permanent. Because the tariff analytically is a tax, under some market conditions its economic costs would be borne in part, ironically, by the producers of crude oil. Alternatively, a quota limitation on imports of foreign crude oil and refined products could be imposed; but it would engender massive distortions and regulatory complications, as demonstrated by the 1959-1973 U.S. quotas on oil imports.
Such government meddling in the oil market 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. Production cuts would have to be coordinated, and political considerations would overwhelm efficiency objectives.
The adverse effects of such policies will harm the oil sector itself. Efficiencies in production will become less important relative to the ability to obtain favors from government officials. The political opponents of the oil industry will find it easier to claim that oil industry “subsidies”—virtually none of which are actual subsidies properly defined—provide a rationale for the imposition of ever-greater regulatory costs and for punitive provisions to be enacted into the tax code.
Notwithstanding the numerous violations of free-market principles inflicted by various federal and state policies, it remains the case that America traditionally has supported the market allocation of resources through the price mechanism as an institution that supports freedom and the enhanced national wealth that benefit ordinary people. The existing policies violating free-market principles do not provide a rationale for even more of them, and the defense of those principles is vastly more important than the short-term alleviation of pain caused by current market conditions. Whatever the rationale, that greater importance cannot be defended once we resort to market manipulation.
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