Oil: Cheap and Too Cheap

Oil is cheap again. Though it’s still double its pre-OPEC (pre-1974) levels, it’s down by about half from its average price of the past 4 years. Overall, this is a good thing. While energy sector stocks have been a drag on some indices, the stock market as a whole – and the US economy as a whole – does better with cheap oil. Consumers save far more than energy companies lose. Geopolitically, cheap oil means less cash for Saudi Arabia, Iran and Russia, all of whom use oil money to cause trouble.

Cheap oil also means less investment in oil exploration and extraction in the US and Canada. Putting aside the virtues of “oil independence”, the North American oil industry has bet a goodly chunk of economic resources on enterprises that depend on OPEC for profitability. At current prices, a lot of the oil in North Dakota and Alberta cannot be profitably extracted. Many producers bought “price insurance” just in case the price of oil crashed – as it has. That insurance will run out over the course of the next year, and if prices remain low, production will drop.

It’s rarely appreciated that OPEC has made more millionaires in Texas, North Dakota and Alberta than it has in Saudi Arabia. When OPEC artificially drives prices up by restricting supply, the benefit accrues equally to all oil producers, whether they are part of OPEC or not. In fact, non-OPEC producers benefit even more because they dont reduce output – they just keep pumping and pocket the premium OPEC secures for them.

OPEC countries today only account for 40% of world oil production. That share is sufficient to manipulate prices because the demand for oil is relatively inflexible – small changes in supply can make for big swings in price. Few are aware that the US would probably have overtaken Saudi Arabia to become the world’s number 2 oil producer this year (after number 1, Russia), were it not for the price crash, which will significantly lower US exploration and production. After years of ramping up, the US and Canada combined now produce more oil than any single country.

Some liberals are uneasy about cheap oil, and about projects like the proposed Keystone XL pipeline, because it facilitates oil use. Since oil is a sort of benchmark fuel source, when it gets cheap, it makes renewables (wind and solar) less attractive. But the only reason oil ever seems cheap is because producers and end users dump a significant fraction of the true cost of oil on the rest of us. When you factor in environmental degradation and political instability, oil gets expensive in a hurry. Some estimates put the break-even price for a gallon of gas at between $10 and $15.

The solution, of course, is to use the government power to tax and regulate to make oil producers and end users pay their own way. Levy higher taxes on fuel oil and gasoline. Require that manufacturers and power companies pay for their CO2 emissions.

OPEC is bad, and its elimination will make the world wealthier and safer. This is not to say that there havent been significant benefits to high oil prices, such as the accelerated development of alternative fuel sources, and improved efforts toward efficiency and conservation. But the US government should give these trends a boost by raising taxes on oil now.

 

Editor’s note: Monday is King Day – the Field Guide returns Wednesday. Share it: https://liberalfieldguide.org/

 

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