Streetwise Professor

January 10, 2016

Protectionism in the Oil Patch: When Someone Says “Fair Markets”, Check Your Wallet

Filed under: Commodities,Economics,Energy,Politics,Regulation — The Professor @ 9:28 pm

The decline in oil prices is producing a predictable political outcome: attempts to prop up the domestic US industry. Some initiatives would make sense regardless of the financial distress of the US upstream sector: the Clinton and Obama administrations in particular have imposed a variety of inefficient regulations and restrictions on US hydrocarbon production, and it would be desirable to roll these back, as is being proposed:

Among the proposals under discussion: Expediting the process for exporting liquefied natural gas, and upgrading infrastructure to move energy to market more quickly and cheaply.

Another top priority for the two Republicans is loosening environmental and other regulations.

But then there’s just the plain stupid:

Some lawmakers are floating the possibility of taking retaliatory trade measures against Saudi Arabia, which has flooded the market with cheap oil in what some analysts see as a bid to drive America’s growing shale oil industry out of business.

. . . .

North Dakota Rep. Kevin Cramer (R) said lawmakers could begin to mull retaliatory tariffs against Saudi Arabia in the future but emphasized he is not advocating for that yet.

“I’m very hesitant to go down that path at this time but clearly that would be a possible option should the Saudis not play fair. Because as much as I advocate for free and open markets, I also advocate for fair markets,” he said.

Saudi Arabia, taking advantage of its low extraction costs, has refused to curb oil production in a bid to expand market share and undercut competitors. This has raised the prospect of the U.S. government taking action to level the playing field for domestic companies.

“I’m not prone to a lot of government intervention in terms of propping industry up, per se. What would be the most helpful is to roll back regulations that get in the way of further development and profitability,” said Cramer, who cited the Endangered Species Act as one burdensome regulation.

“Obviously they have access to our market and I suppose to some degree there is a role that can be played there. I’m not at the point where I’m ready to advocate tariffs or restricting their access necessarily,” he added.

Any tariff on Saudi imports would be special interest protectionism pure and simple, tarted up in the usual rhetoric (and whining) used to justify protectionist measures. “Fair markets” is a sure tell. Anyone who says “I’m for free markets but they should be fair markets” is a liar, and should drop the pretense. Any such person is all about protecting a favored industry or firm. When someone, regardless of party, says “fair markets”, I strongly advise you to check your wallet, because they are trying to rob you.

And why should Saudi Arabia “refuse to curb oil production”? Indeed, “curbing oil production” is the exercise of market power, for which the US (rightly) criticized OPEC and the Saudis in the past. What’s more, low cost producers are the ones who should sustain output in the face of a demand decline: high cost producers are the ones who should cut back.

Furthermore, although North Dakota is an oil long, the US as whole is an oil short, still producing only about 1/2 of its consumption, despite the spurt in oil production in the past 5-6 years. So low oil prices are still in the interests of the US.

It should also be noted that the “flooding the market with cheap oil” meme is vastly overstated. Saudi output in June, 2014, right before the price collapse began, was about 10mm bpd. It is now about 10.5 mm bpd. That difference represents a whopping .5 percent of world output. Even given an elasticity of 10 (which is probably too high) that could cause at most at 5 percent decline in prices. As I write, Brent just went below $33/bbl, and hence is down almost exactly 70 percent off its pre-collapse levels. So this collapse is not the result of the Saudis flooding the market.

Nor are the Saudis engaged in some predatory pricing strategy. At least I doubt that they are, because such a strategy would be irrational.

The price decline is the result of increased output in a variety of places (including the US), but mainly due to a steep decline in demand growth, especially from China.

Yes, the upstream sector in the US is suffering severe financial distress. So be it. That’s the nature of the business, and the nature of a market system generally. Resources should exit sectors that suffer demand declines. They should not be propped up through trade restrictions, especially trade restrictions that will impose far greater costs on the US economy as a whole than they will benefit one sector in that economy.

It is also perversely ironic that the very same Republicans (I am speaking of the individual legislators, like Murkowski and Cramer, not the party as a whole) who pushed for ending the idiotic export ban are now mooting an equally idiotic restriction in imports. This makes it plain that it’s not about principle, in the least. It’s all special interest politics. That’s not surprising, but it’s not admirable. And it’s not any better when Republicans push it than when Democrats and Obama do.

So yes, eliminate or cut back inefficient restrictions that a relentlessly anti-hydrocarbon administration has imposed, in order to eliminate unnecessary burdens on US oil and gas production that hurt both US producers and consumers in the US and around the world. But don’t impose large costs on American consumers of oil in order to prop up the US upstream sector. The sector should shrink if the demand for its product declines due to increased production elsewhere, or reduced demand. So be it.

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6 Comments »

  1. SWP:

    You ALWAYS do this. Just when Vlad is about to punch out for the night. A new SWP post. The man must never sleep. How did he EVER have kids?

    Congrats on 10yrs. Vlad knows. Wrong thread. Too bad. It’s how Vlad rolls.

    Looking fwd to the next 10yrs of ur posts.

    May we cross paths (and NOT swords) on a battlefield in 2016. Rec’d Custer’s Trials for Xmas. Good read. Also Red Notice. Have Vlad’s relatives been ‘spying’ on Vlad’s following of ur posts? Truth is indeed stranger than fiction.

    Good night, Kind Sir.

    VVP

    PS Should Hillary invite John Edwards onto her ticket? Now THERE’s a REAL philanderer!

    Comment by Vlad — January 10, 2016 @ 10:21 pm

  2. Quite right. I wouldn’t blame any small, independent oil company lobbying the government for protection given there is an argument to be made regarding the strategic value of having a domestic oil industry and the fact that the US has historically intervened to protect domestic production for decades in all areas of the economy, some of which are far less deserving (I’m not saying it is right, just that I wouldn’t blame them and the argument is there to be made). But the majors can make no such argument.

    ConocoPhillips must be hurting badly now: they sold off their midstream and downstream business to form Phillips66 in 2012 when it looked as though E&P was the only area in which to make money. Now the other majors are finding themselves dependent on their downstream businesses to prop up their cash-hungry E&P entities. The reason the majors are all squawking about the oil price and (no doubt) lobbying their respective governments hard to introduce protectionist measures is in large part due to the fact that, having enjoyed bumper prices for a decade or so, they have no idea how to run a business during lean times. I wrote about this some time ago, likening the situation to an army which finds itself at war with peacetime officers running the show.

    Comment by Jake Barnes — January 11, 2016 @ 10:52 am

  3. @Jake
    Couldn’t agree more about running an oil company at this time. Most US oil companies are now run by people with a herd mentality. The executive management of many (nearly all) US mid-sized companies couldn’t find a quart of oil in WalMart.
    If one company spins off downstream then followed by numerous others. The strategy is-always better in the middle of the herd so not out on a limb personally.

    I agree 100% with SWP-no subsidies-not even a single penny. Once oil price increases sufficiently then oil shale drilling will increase and US production in turn.

    Time to thin the herd.

    Comment by pahoben — January 11, 2016 @ 11:42 am

  4. @Professor,
    Not sure about importing half of demand at this time. I looked a couple weeks ago and as I remember the net of imports versus refined products exports was around 6 MMBOPD and domestic production around 9 MMBOPD. I could be wrong or you maybe including the exported refined products as a component of US demand but only a 10% difference in either case.

    Comment by pahoben — January 11, 2016 @ 12:15 pm

  5. This just mirrors the old joke that the strongest believer in government intervention is a free market businessman facing a couple of lousy quarters.

    Comment by Sotos — January 11, 2016 @ 12:21 pm

  6. I would love to hear a politician say, “I’m in favor of fair trade, but it must also be free.”

    One guy who is really screwed by the apparent upcoming multi-year down cycle in oil prices is Jeff Immelt of GE. He has just completed a big repositioning of GE into industrial products, heavily weighted to oil-production equipment. (He also threw a lot of investment, including GE’s avionics headquarters, into China.)

    Comment by srp — January 16, 2016 @ 1:53 am

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