Streetwise Professor

March 8, 2020

Note to VVP: US Shale’s Pain Does Not Equate to Russia’s Gain. Predatory Pricing Is Futile.

Filed under: Commodities,Economics,Energy,Russia — cpirrong @ 6:03 pm

Oil is crashing, with WTI trading at a 33 handle, down 20+ percent since Friday.

The first leg down in oil prices was caused by the coronavirus demand shock in China. This most recent free-fall is a response to Russia’s refusal to agree with OPEC to extend the existing OPEC+ cuts, and deepen them in response to the demand decline; and the Saudis’ reaction to the Russians, specifically, to put the output pedal to the metal.

The Saudi reaction to the Russians is a classic cartel defector punishment strategy. The Russian demurral is more difficult to understand. One story circulating is that Putin wants to punish US shale. If so, he’s a fool. And worse, a fool who fails to learn from the foolishness of others, e.g., the Saudis whose predatory pricing strategy in 2014-2016 failed miserably.

Yes, cratering the price of oil will inflict pain on US shale producers. They will suffer financial losses, and will curtail drilling and output. But US pain does not equate to Russian gain. Russia will incur substantial losses from prices in the 30s–and more pain if prices go into the 20s, as is possible. But Russia will not recoup this pain with future gains. If and when they (and OPEC) decide they’ve had enough, and curtail output to raise prices, US output will respond accordingly.

US rocks can outwait Putin. Yes, reduced activity will damage the shale supply chain, and it will take some time to recover, but as the Saudis found out in 2016, the flexibility of the US oil sector allowed it to rebound extremely rapidly when prices rose. The resource remained. The human capital remained. When OPEC+ went into effect, US oil output soon exceeded the pre-2014 price crash levels, which sharply limited the upside for the Saudis and Russians.

I am currently putting finishing touches on a paper which, among other things, demonstrates the futility of the Saudi strategy in 2014–and the Russian strategy (if that’s what it is) today. I document learning-by-doing economies in the US shale sector. If these economies are big enough, lost output today due to predatory Saudi or Russian behavior translates into lower US productivity in the future. That means that Saudi/Russian price cutting today raises their rivals’ costs in the future, which could lead to higher future Saudi/Russian profits then.

But the empirical estimates show that the US productivity losses due to foregone learning are very small, and hardly allow the predators to recoup the huge costs they incur from their predatory strategies. Putting the Saudis and Russians together, $10/bbl price cuts today cost them on the order of $230 million/day: $20/bbl cuts cost them around $460 million/day. There is no way that the higher future cost of US oil production due to lost learning opportunities will allow the predators to recoup these losses in the future by raising the ceiling that US shale puts on world oil prices.

Predatory pricing strategies are almost always futile. They are definitely futile with regards to the US shale sector. If Putin is indeed pursuing a predatory path, he is cutting off his own nose to spite his face.

So go ahead, Vova. Knock yourself out.

March 2, 2020

Be Careful What You Ask For, Progressives: A Failure of the US to Respond to Coronavirus Would Discredit the Progressive Worldview, Not Trump

Filed under: Uncategorized — cpirrong @ 9:03 pm

The latest leftist/statist/progressive/establishment/”elite” freakout is over Trump’s alleged incompetence at addressing the Coronavirus. This is an illustration of their utter cluelessness, because the responsibility for any failure in addressing a potential pandemic utterly discredits the entire progressive vision.

In that vision, a wise, nay, omniscient, technocratic elite foresees problems, devises elegant solutions, and saves the world. In that vision, elected officials–legislators, but especially the chief executive–are at best irrelevant distractions, but more likely meddling interferers who undermine the brilliant designs of the administrative apparatus.

So if the government fails, it is on the permanent government, not on the hapless sod at the top who vainly pulls the levers of the state machinery, to no avail (because the mandarins are far too sophisticated to respond to the commands of such a boorish boob–they know better!).

We already have a perfect illustration of the disconnect between the vanity of the administrative state and its actual competence. The geniuses from the government who are here to help put infected individuals from a cruise ship on an aircraft . . . that also carried (previously!) non-infected individuals. The response of the State Department is priceless. It should be framed for posterity:

“At the end of the day, the State Department had a decision to make, informed by our inter-agency partners, and we went ahead and made that decision,” Walters said. “And the decision, I think, was the right one in bringing those people home.”

Again with the fucking “inter-agency”! Our overlords to whom we owe utter obeisance.!

But there’s more from M. Walters:

“What I’d say is that the chief of mission, right, through the U.S. embassy, is ultimately the head of all executive branch activities. [Er, mere peasant that I am, I thought from reading the Constitution that the President of the United States is “ultimately the head of all executive branch activities.” Silly me!] So when we are very careful about taking responsibility for the decision, the State Department is – that is the embassy. The State Department was running the aviation mission, and the decision to put the people into that isolation area initially to provide some time for discussion and for onward, afterwards, is a State Department decision.”

Yes, we are in the best of hands. The best of hands! How dare you question them, peasant!

Regardless of what you think about Trump’s competence, it cannot be less than the bureaucracy’s. Yet the better thans insist on demanding we defer to the bureaucracy. Because they know better.

And then, they are shocked–shocked!–when people with a modicum of common sense and who rely on empirical reality choose Trump over them.

Maybe you could be this stupid. And arrogant. If you tried really, really hard.

March 1, 2020

Paul Romer Projects

Filed under: Economics,Politics,Regulation — cpirrong @ 6:16 pm

In a reply to the Paul Romer post, ex-colleague and friend Scott points out the richness of Romer calling for a “new humility” among economists. But not all economists, mind you, just those who value freedom and express skepticism about regulation:

Among these pretend economists, the ones who prized supposed freedom (especially freedom from regulation) over all other concerns proved most useful—not to society at large but to companies that wanted the leeway to generate a profit even if they did pervasive harm in the process. 

This brings to mind Hanna Arendt’s observation: “One of the greatest advantages of the totalitarian elites of the twenties and thirties was to turn any statement of fact into a question of motive.” This is exactly what Romer does. He ascribes venal motives to those who dare disagree with his eminence. He has precious few facts in his article, but casts many aspersions on motives of those with whom he disagrees.

Romer again refers to economists plural, but provides a single illustration–Alan Greenspan. To make him the Representative Agent for an entire swath of the economics profession is utterly ridiculous. He was the head of an economics consulting firm for decades before ascending to the Fed. He never held an academic appointment. He did not publish in peer-reviewed journals. He is an eminently bad person to serve as the epitome of regulation-skeptical economists.

Further, Romer has things exactly upside down. It was–and is–the pro-regulatory/pro-state/pro-government contingent of the economics profession (which has always represented a majority) that could have used, and could use, a dose of humility. Always dismissive of the knowledge problem, they believed that they could design regulatory and legislative schemes that would achieve superior outcomes, only to find out that unintended consequences are a bitch, and regulatory capture undermines the most well-intended schemes.

Indeed, in financial regulation in particular, major financial institutions play B’rer Rabbit, begging not to be thrown in the regulation briar patch, only to profit quite well from it.

In fact, it has long been government/regulation-skeptical economists who have counseled against hubris. In a book tellingly titled “The Fatal Conceit,” Hayek famously wrote: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The main issue I’ve always had with this quote is that it clearly expresses what Hayek thought economics should do, but did not accurately express the views of the profession at large. Those who view economies and markets as complex systems, as emergent orders, are very dubious of their ability–or the ability of anyone–to impose their designs. But they are, and always have been, a minority.

Another example of a great economist who was humble about attempts to control such complex systems via government was Adam Smith, who famously said:

The man of system, on the contrary, is apt to be very wise in his own conceit [there’s that word again]; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it.

He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

In sum, Paul Romer is projecting. As Smith recognized centuries ago, and Hayek echoed many years later, it is the statists who need humility, and those who advocate a reliance on freedom often do so out of a humble conviction of the difficulty in even understanding the operation of complex systems, let alone controlling or regulating them.

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