Colluding With the (Oil) Enemy

RealClear Energy
April 8, 2020

On April 2, Ryan Sitton, one of three members of the Texas Railroad Commission, communicated with officials from Saudi Arabia and Russia about coordinating cuts in oil production. Just a few years ago, the notion that an American politician would talk with foreign producers about how to prop up oil prices would have been considered colluding with the enemy. But the coronavirus pandemic, along with the collapse in oil demand and oil prices, requires a rethinking of ideas that have dominated American energy policy for decades.

That rethinking requires accepting two truths: First, we have to discard what energy economist Roger Stern has dubbed “scarcity ideology.” Second – and this will be difficult – the U.S. and other oil producers are going to have to agree to something that looks like a global version of OPEC.

We have been inundated with predictions about scarcity and societal collapse since the days of Thomas Malthus. In 1914, a federal agency, the Bureau of Mines, predicted that world oil supplies would be depleted within ten years. In 1972, the Club of Rome predicted that the world would be out of oil by 1992 and out of natural gas by 1993.

In an essay published in 2015, Stern wrote that continued claims about oil scarcity “both created and met demand for apocalyptic ideas.” He continued, saying that forecasts about peak oil (remember that?) “all of which proved wrong, repeatedly led policymakers to assume that rival powers sought to seize dwindling supplies or that disaffected exporter-states would decline to sell.”

But today’s battered oil industry shows, yet again, that the recurring problem in the global petroleum sector has never been too little oil, but too much. At the end of last month, oil prices collapsed to about $20 for the first time in nearly two decades. The price collapse threatens the domestic oil and gas sector, which over the past few years has created hundreds of thousands of high-paying jobs and dramatically reduced the cost of oil and natural gas for consumers. In 2019, American motorists were paying less for gasoline, in real terms, than they were in the late 1970s and early 1980s. Maintaining a healthy domestic oil and gas business is important for both employment and energy security.

For those unfamiliar with the history of the energy sector, putting limits on global oil production sounds absurd. But for eight decades, the industry has relied on limits known as “allowables.” That history can be traced to 1930 when crude oil was selling for about $1.30 per barrel. That same year, an itinerant preacher named Dad Joiner drilled the Daisy Bradford No. 3, and in doing so, discovered the massive East Texas Field. An unrestrained surge in production from the field crushed oil prices and by mid-1931 in parts of East Texas, crude was selling for as little as 3 cents per barrel. That August, to preserve the integrity of the oilfield and save the industry from collapse, Texas Governor Ross Sterling declared martial law in the East Texas Field and dispatched National Guard troops to shut down all production in the region.

Years of legal and political wrangling ensued and in 1935, another Texan, U.S. Senator Tom Connally, engineered the passage of a federal law (the felicitously named Connally Hot Oil Act) that confirmed the Texas Railroad Commission’s authority to limit oil production. The commission did so by meeting every month in Austin where they would set “allowables” that limited the amount of oil each operator could produce. The aim was to, as closely as possible, match oil production with oil demand. By limiting production in Texas, the world’s most important oil province, the Railroad Commission effectively determined world oil supplies – and prices – for the next four decades.

In 1973, OPEC imposed an oil embargo and imposed a system of allowables on its members. The cartel’s influence over supplies and prices lasted until 2014, when it was forced to admit that world markets were oversupplied due to the surge in American shale oil production. Since then, global oil markets have been chaotic, with every producer seeking to gain market share at the expense of others.

Some Texas producers have called on the Railroad Commission to reinstate allowables to rein in production. Last week, Petrobras, the state-owned Brazilian oil giant, announced it would cut production by nine percent.

But the obvious long-term solution to the boom-bust oil cycle is a global system of allowables for the world’s biggest producers. Call it OPEC ++. Enforcing allowables won’t be easy. But oil is a strategic commodity. One third of global primary energy and 94 percent of the world’s transportation fuel comes from oil. Every major oil producing country wants to protect its industry and the jobs and security that it provides. With the global economy teetering on the edge of an economic precipice, oil producers are going to have to share the pain of production cuts in order to stabilize prices.

Without such an agreement, the oil market will remain in turmoil and countries may resort to tariffs, price wars, or embargoes to protect their domestic producers – any of which could be more painful than a deal that reduces production across the board.

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