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The oil market doesn’t need an intervention

By George LandrithThe Huntsville Item

In late spring, oil prices dipped below zero for the first time ever. Futures contracts for May delivery traded as low as negative $37 a barrel, as producers and speculators paid refineries and storage facilities to take excess crude off their hands. 

In some sense, this historic moment was inevitable. Oil markets are completely saturated. Worldwide coronavirus lockdowns have depressed energy demand. And in March, Saudi Arabia and Russia announced they would increase production, thus exacerbating the glut.

President Trump has tried to help beleaguered U.S. producers. He recently mediated a deal between Saudi Arabia, Russia, and other major oil producers, who collectively agreed to cut production by nearly 10 million barrels a day.

But prices are still falling. And now, the White House is toying with other ways to prop up U.S. oil producers, ranging from tariffs on imported oil to direct cash payments to energy companies.

This desire to help energy companies, and the millions of workers they employ, is commendable — but ultimately counterproductive. In the long run, the industry will emerge stronger if the White House allows the free market to resolve this crisis.

This pandemic-induced economic crisis is going to be painful for the energy sector. Cost-cutting and layoffs are already underway.

But the industry is strong and adaptive, and has bounced back from past crises by investing in technology. In fact, economic pressure encourages the kind of innovation and belt-tightening that helps companies thrive in the long run.

The United States last faced low oil prices in 2014 and 2015, when Saudi Arabia ramped up output to try to cripple U.S. producers that specialized in fracking — a technique used to extract oil from underground shale rock. By early 2016, prices had dropped below $30 a barrel, well below what U.S. shale producers needed to break even.

The government didn’t come to the rescue, which forced frackers to get creative. They researched how to extract more oil for less, and came up with a variety of new techniques, like drilling several wells simultaneously and using drones to detect faulty equipment. As a result, the average break-even price for frackers dropped from $69 a barrel in 2014 to an average of $40 a barrel by 2017. Had the government tried to solve the problem by slapping tariffs on Saudi crude, the U.S. oil industry likely would have never set its all-time production record of 13.1 million barrels a day in February.

We can be confident the U.S. energy industry will apply its ingenuity to this crisis, too — because these days, it excels at invention. In 2019, the oil and gas sector increased adoption of digital technologies, including cloud data storage and new software. Over the next five years, digitizing could slash the cost of oil production by almost 10 percent.

By using sensor technology — tiny, data-tracking devices attached to oil-field gear — producer ConocoPhillips recently cut in half the amount of time it took to drill new wells in South Texas. Other companies are using data analytics to search for the best drilling locations.

In short, the pressures of a downturn are likely to encourage even more future-focused transformation. The industry doesn’t need to hide behind tariffs. If we trust the free market to encourage creativity, in the long run, we’ll all benefit from a cheaper and more efficient energy supply.


The Drop In Oil Prices: Good Or Bad?

By David R. HendersonHoover Institution

Crude oil prices fell dramatically over the weekend. Between March 4 and March 9, Brent crude, the international benchmark, fell from $51.13 to $34.36 per barrel, a drop of 32.8 percent. As of this writing (the afternoon of March 10, EDT), the price has recovered to $36.89 per barrel.  The price of U.S. West Texas Intermediate crude, the standard measure of U.S. oil prices, fell from $46.78 on March 4 to $31.13 on March 9, a drop of 33.5 percent. Pippa Stevens at CNBC wrote that “U.S. West Texas Intermediate crude and international benchmark Brent crude are both pacing for their worst day since 1991.”

Why worst? Implicit in Stevens’s statement is the idea that low oil prices are bad. All other things equal, of course, low oil prices are bad for oil producers. But also, all other things equal, low oil prices are good for oil users. And the latter includes all of us. How do we assess whether the net effect of the plunge in oil prices is good or bad? We have to look at why they fell suddenly. We pretty much know why: a temporary collapse of the Organization of Petroleum Exporting Countries (OPEC.) For that reason, the drop in oil prices over the weekend is good. It’s roughly a wash for the U.S. economy and it’s good for the overall world economy.

A most useful principle I learned in my Ph.D. economics program at UCLA, about which Professor Benjamin Klein never failed to remind his students, is “Never reason from a price change.” Scott Sumner, an economist at the Mercatus Center and one of my co-bloggers at EconLog, often points that out in his posts.

Let’s apply that lesson here. There are three (and only three) reasons that oil prices drop: (1) demand decreases, (2) supply increases, or (3) the monopoly power of oil producers falls.

When economists say that demand decreases, we mean something very specific—that at any given price, the amount demanded decreases. There are two main ways that can happen: a slowing of the world economy or an increase in the supply of a substitute.

If the world economy slows—and it certainly looks as if it has slowed, or will, due to the COVID-19 virus and people’s reaction to it—the demand for oil will fall. With a given supply, that will cause the price of oil to fall. The fall in the price of oil is not bad per se; rather, it’s a consequence of something bad, namely, the slowing of the world economy. And it certainly appears that a fall in demand due to a slowing economy caused prices to fall before last weekend. But it’s unlikely that there was a sudden fall in demand last weekend. We have to look elsewhere.  

The other possible cause of a fall in the demand for oil is an increase in the supply of a substitute for oil. If, for example, solar or nuclear energy became more competitive, the demand for oil would fall. In that case, the fall in oil’s price would be a sign of something good happening in the economy. Did solar, nuclear, or any other energy source suddenly become more competitive over this weekend? No.  So that’s not it.

How about an increase in supply? If supply increases, then, with a given demand, prices will fall. Notice that I’m using the word “supply” to mean not the quantity supplied, but the whole supply curve. When an economist says that supply increased, he means that at any given price, the quantity supplied has increased. The whole supply curve has shifted to the right. This sounds wonky and may remind you of an old economics class in which the professor insisted on the distinction between a shift in supply and a movement along a stable supply curve. But here we need a little wonkiness to help us analyze.

But there were no major discoveries of oil or breakthroughs in technology over the weekend that would cause the supply to increase. So that’s not what drove prices down.

There’s one culprit left: a decrease in monopoly power. If buyers and sellers in the stock market think that a major monopolist in the world market has lost market power, the world price of oil will fall. So let’s look more carefully at OPEC to see what went on last weekend.

First, recall that OPEC is a cartel. Government officials of the member countries get together and try to agree on a price. They want a price above what the competitive, non-colluding price would be. To achieve that cartel price, the members must produce an output below the output they would ideally like to produce. Each firm or, more accurately, government (since we’re talking about OPEC) would like to produce more and have every other country produce less. The members of OPEC meet regularly in Vienna to hash out their differences and try to reach an agreement. This time, though, there was real tension between Saudi Arabia’s desires and those of Russia. OPEC lists its members on its website, and although the Russians attended the latest meeting, and typically attend OPEC meetings, Russia is not, and never has been, an OPEC member.  

Saudi Arabia is the most important OPEC producer; Russia is the most important non-OPEC producer that attends the meeting. This time, the Saudis and the Russians had a big disagreement. The Saudis wanted to slow or stop the price erosion that had happened due to the drop in demand by cutting output: that of OPEC members and that of other countries that attend OPEC meetings but are not members. The Russians wanted the output cut too but didn’t want to be the ones doing the cutting. As CNBC’s Brian Sullivan put it on Friday, they wanted to have their cake and eat it too. In that respect, the Russians are like the non-Saudi members of OPEC: all of them want the Saudis to cut output. Although the violin I will play for the Saudis’ predicament is very tiny, it is true that they have traditionally been the “swing producer:” the country that sucks it up and reduces output to maintain the price while many other members of the cartel cheat like crazy. At times, the Saudis have produced as little as 4 million barrels a day to support the price; at other times, they have said the hell with it and have produced as much as 10 million barrels per day.

This time the Saudis said the hell with it. They will produce more and the Russians will produce more. Thus the lower price. And it doesn’t take a whole lot more production to drop the price. The reason is that the demand for oil is inelastic: a one percent increase in output will lead to a ten percent drop in price. So all it takes for a 30 percent drop in price is a three percent increase in output.

Is it bad that the price of oil will drop due to a reduction in monopoly power? No, it’s good. Ever since the fall of 1973, when OPEC raised the world price of oil from $3 per barrel to $11, OPEC has had some monopoly power in the world oil market. This causes the price to be higher than the competitive price would be and we oil users respond by using less oil than we would use at that lower competitive price. When the monopoly power comes about, not due to innovation or invention, but due to collusion, as with OPEC, economists almost unanimously object to monopoly: it holds output off the market for which consumers would pay an amount greater than the cost of production. This underproduction causes what economists call a “deadweight loss,” a loss to consumers that is not captured by producers. That’s what OPEC does. In his article on monopoly for The Concise Encyclopedia of Economics, the late Nobel Prize winner and University of Chicago (and Hoover) economist George Stigler laid out the reasoning behind deadweight loss.

So the cut in the price brings the world oil market closer to the competitive price.

Does that mean that the price cut is good for the United States? No. The price cut is good for any country that is a net importer of oil. In recent decades, therefore, the United States would have gained big time from the cut in the world price. The loss to U.S. producers would have been less than the gain to U.S. consumers because we consumers would have gained on every barrel we used and the producers would have lost on the smaller number of barrels they produced.

But something important has happened in the last decade: fracking. As I noted in my most recent Defining Ideas article, fracking substantially increased the U.S. supply of oil and natural gas. In December 2019, the United States became, for the first time since 1949, a net exporter of oil. So the drop in prices is bad for the U.S. economy as a whole: the loss to the producers will exceed the gain to consumers. But it’s only slightly bad because the United States is barely a net exporter.

For the world economy as a whole, then, the drop in oil prices due to demonopolization is a net plus. That should be no more surprising than the fact that the increase in competition in the retail sector is a net plus.

So why has the stock market fallen so much? Part of the reason is, no doubt, the increased panic, possibly justified, about the loss in output due to the Covid-19 virus. You might expect that if the only event affecting the stock market was OPEC’s temporary loss in monopoly power, the losses to industries that produce energy would be only slightly larger than the gain to industries that use energy as an input. But that ignores the fact that a large percentage of the gain from the drop in price is to final consumers, and most of us consumers don’t sell stock in our wealth. There’s no stock called David Henderson, Inc., for example. So a large part of the gain is not visible on the stock market.

French economist Frederic Bastiat wrote, back in the 1840s, that we should always take account of the unseen as well as the seen. The seen is the stock market losses of energy producers. The unseen is the gain to ultimate consumers.

We don’t know what will happen in the next few months, either with the Covid-19 virus, the world economy, the stock market, or oil prices. As Danish physicist Niels Bohr said, “Prediction is very difficult, especially about the future.” But we should be clear that the drop in oil prices due to OPEC’s loss of pricing power is a gain to the world, and close to a wash for the United States.


Attack on Saudi Arabia Proves Need for Layered Defensive System

By George LandrithNewsmax

Just last week, Houthi rebels in Yemen, who are closely aligned with Iran, claimed credit for a drone attack on Saudi oil processing facilities.

News changes fast — a surprising development is that now the Houthi’s say Iran is responsible for the attack and that the Iranians have more attacks planned in the near future. The Houthi’s also vowed not to launch any additional attacks themselves.

Something that is not surprising is that missile defense critics in the U.S. are now arguing that the drone attack proves that missile defense doesn’t work. This is, of course, entirely without merit. Meanwhile, Russian President Vladimir Putin is offering Russian missile defense systems to “help” protect against future attacks from its client state of Iran. Let that sink in.

Given Russia’s intimate relationship with Iran, it is entirely possible the attack was coordinated with Russia. It is not as if this would be out of character for Putin. Of course, Putin has never done anything on the international stage simply to be helpful. He is simply trying to help himself and advance his ambitions.

Imagine if he could get U.S. allies to insert and integrate Russian hardware into their U.S.-made defensive systems. Imagine the hacking potential on something like that. Putin would love to learn more about our defensive systems. For that reason, the U.S. earlier this year canceled sales of high-tech American defensive systems to Turkey, a member of NATO, after they integrated Russian equipment in their defensive systems.

But back to the missile defense critics in the U.S. who are unwittingly helping Putin.

Right now very little is actually known about the attack. While preliminary indications are it was a drone attack, we are not even certain precisely what weapons were used. It is profoundly unhelpful to jump to hasty conclusions to support a misguided ideology — particularly when the primary beneficiary of those hasty conclusions will be an adversary like Putin’s Russia.

Beyond not jumping to silly conclusions without any real facts, it is important to realize that an effective missile defense system is layered. Parts of the system protect against ICBMs which actually at some point in their flight are out of the Earth’s atmosphere. Parts of the system protect against intermediate range missiles and other parts protect against shorter range missiles. Each of these missiles has different travel paths and different vulnerabilities. Thus different defenses are needed.

In football, a good defensive coordinator employs a different defense if the opposing team needs only one yard to score than he would if the opposition need twenty-five yards to score. The same concept is true with missile defense.

Having only one layer of missile defense in place to defend against all sorts of attacks leaves the region vulnerable to the other risks. For example, the Patriot defensive missile system is designed to protect against high-flying targets such as jets and ballistic missiles. It wasn’t designed to defend against low flying drones and short range cruise missiles. Patriot’s radars are not intended to scan such low flying means of attack. Nor was Patriot designed to intercept ICBM’s just outside the Earth’s atmosphere. But we know the Patriot system works very well as we’ve seen it in real life combat defend both troops and civilian populations from missile attack.

Criticizing any particular layer of missile defense for not stopping an attack that it was never designed or intended to stop is like criticizing a 350 pound defensive nose tackle for not doing a good job of racing down the sideline to cover a speedy wide receiver. A good defensive football team is made up of different parts, with different skills and capabilities. Together they are a formidable defense. But playing out of position, they are ineffective.

To defend Saudi oil faculties, they would need a layered system — one that has the ability to protect against ballistic missile attack as well as drones and low-flying cruise missiles. Missile defense critics know this, but they don’t care. They simply want to use an unfortunate news event to promote their misguided anti-missile defense ideology in hopes of a short-term political victory.


Oil Export Momentum

Support is growing to repeal a Nixon-era ban that Iran and Russia love.

Wall Street Journal

oil-well-drillingThe Washington news isn’t all bad these days: Republicans and some Democrats are working hard to gather enough votes to repeal the 40-year ban on exporting crude oil. With gasoline prices hitting new lows, now is the right political moment to do something right for the economy and national security.

The ban is a relic from the Nixon era when oil prices spiked and OPEC began. America’s unconventional oil boom has changed everything. U.S. crude production bottomed in 2008 at about seven million barrels per day and is now more than 11 million. The Energy Information Administration estimates that U.S. output could hit 18 million barrels a day by 2040. Crude inventories are at an 80-year high, and imports declined nearly 30% between 2005 and 2013.

The export ban is, paradoxically, one of the biggest threats to this U.S. production boom. The decline in oil prices over the past year has forced U.S. producers to slash investment and cancel projects. The U.S. rig count has dropped 50% since last autumn, and the industry has cut more than 125,000 jobs. Lifting the ban would offer new markets for U.S. oil and mean fewer layoffs. Continue reading


What’s Up With the Prices at the Pump?

by Marita Noon     •     Breitbart News Network

Gas Can Man Dancing at low priceFirst, Saudi Arabia drove down the price of oil by increasing its production, which gave Americans a welcome drop in prices at the pump. Could the kingdom now be pushing them back up?

Prices at the pump have gone up nearly 40 cents a gallon from the January low—60 cents in California. They will continue to rise while the price of crude oil remains low. Based on explanations, the jump was expected. Every year, at this time, refineries shut down to make adjustments from the “winter blend” to the “summer blend.” It is “refinery maintenance season.”

However this year, the increase is exacerbated. Continue reading


Foreign Firm Funding U.S. Green Groups Tied to State-Owned Russian Oil Company

Executives at a Bermudan firm funneling money to U.S. environmentalists run investment funds with Russian

by Lachlan Markay     •     Washington Free Beacon

oil-well-drillingA shadowy Bermudan company that has funneled tens of millions of dollars to anti-fracking environmentalist groups in the United States is run by executives with deep ties to Russian oil interests and offshore money laundering schemes involving members of President Vladimir Putin’s inner circle.

One of those executives, Nicholas Hoskins, is a director at a hedge fund management firm that has invested heavily in Russian oil and gas. He is also senior counsel at the Bermudan law firm Wakefield Quin and the vice president of a London-based investment firm whose president until recently chaired the board of the state-owned Russian oil company Rosneft.

In addition to those roles, Hoskins is a director at a company called Klein Ltd. No one knows where that firm’s money comes from. Its only publicly documented activities have been transfers of $23 million to U.S. environmentalist groups that push policies that would hamstring surging American oil and gas production, which has hurt Russia’s energy-reliant economy. Continue reading


Debunking the Anti-Fracking Fearmongers

by Alex B. Berezow     •     RealClearScience

frackingWorld events have made it quite clear to most Americans that we should develop more of our own energy sources. Reducing our reliance on foreign oil by exploiting the natural gas under our feet is not only smart foreign policy but also smart environmental policy: Natural gas burns cleaner than coal or oil, and it has already lowered our CO2 emissions. Natural gas is a win for America and the planet.

But not according to anti-technology environmentalists, who have made all sorts of wild, unsubstantiated claims about the supposed harms of fracking. Three claims in particular are worth examining: (1) Fracking causes a dangerous leakage of methane into drinking water; (2) Fracking causes earthquakes; and (3) Fracking chemicals contaminate drinking water. Continue reading


Putting The Truth-o-Meter On Obama’s State Of The Union Energy Claims

“Funneling taxpayer money to support green energy distorts the market and creates a huge amount of economic inefficiency — like a homeowner being pressured to use Uncle Bob for home repairs, even though the work is slow, poor quality and needlessly expensive, just because he’s family.”

by Merrill Matthews

Did President Obama somehow become the most pro-energy president in decades? You could be forgiven if that was your take-away from his comments on energy policy in his State of the Union speech.

But applying the Truth-o-Meter to several of his claims reveals a very different administration than the one on display during Obama’s speech.

Claim 1. “We produce more oil at home than we have in 15 years.”

The vast majority of increased oil and gas production has come from drilling on private lands, over which — thankfully — the Obama administration has no control. Continue reading


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