No, the Rail­road Com­mis­sion should not cut pro­duc­tion

Houston Chronicle - - TEXASINC - By Ed Hirs

Will the Rail­road Com­mis­sion of Texas kow­tow to Pioneer Nat­u­ral Re­sources Co. and Pars­ley En­ergy Inc. and cut pro­duc­tion across Texas in or­der to re­duce sup­ply and in­crease prices? Re­ally? In the face of a global re­ces­sion? The com­pa­nies’ ex­ec­u­tives say that to do so would pro­tect em­ploy­ment. For whom?

The shale oil pro­duc­ers, com­monly re­ferred to as frack­ers, are the high­est-cost pro­duc­ers in the global oil mar­ket. They have al­ways been vul­ner­a­ble to a very pre­dictable price war led by low-cost pro­duc­ers. The 2014-16 price war cost the U.S. oil in­dus­try 300-plus bank­rupt­cies, more than $250 bil­lion in lost cap­i­tal and 250,000 jobs.

Fol­low­ing the De­cem­ber 2016 truce among OPEC mem­bers and Rus­sia that ended the price war, for­mer Saudi oil min­is­ter Ali Al-Naimi an­tic­i­pated the break­down of the car­tel and the cur­rent price war, fa­mously stat­ing, “The un­for­tu­nate part is we tend to cheat.”

When the oil ex­port ban was lifted at the de­mand of frack­ers, the U.S. oil mar­ket had no fur­ther mar­ket bar­ri­ers. Had the ban not been lifted, U.S. re­fin­ers would have had in­cen­tives to re­tool to process the lighter crude oils from the shale plays. To­day, the U.S. ex­ports as much as 3 mil­lion bar­rels per day of these light crudes into the world mar­ket. Oil that costs as much as $40 per bar­rel at the well­head to pro­duce is com­pet­ing head-to-head with oil that costs as lit­tle as $5 per bar­rel. The net­work eco­nomics are com­plete. What hap­pens at one node im­pacts an­other. What hap­pens in Riyadh im­pacts the Per­mian.

Can the Rail­road Com­mis­sion re­duce pro­duc­tion in Texas? Yes. Will it save jobs? No. Will it raise oil prices? No. The Fi­nan­cial Times re­ports that U.S. pro­duc­ers have en­gaged in di­rect dis­cus­sions with OPEC min­is­ters. I hope not.

Pres­i­dent Dwight D. Eisen­hower rec­og­nized the strate­gic dan­ger of de­pend­ing on for­eign crude. He re­fused to com­mit the U.S. mil­i­tary in 1956 to as­sist Bri­tain, France and Is­rael in re­cov­er­ing the Suez Canal. He is re­ported to have said “Let them boil in their own oil.” Fur­ther, he in­sti­tuted an oil im­port quota re­strict­ing im­ports to no more than 12 per­cent of do­mes­tic pro­duc­tion.

Con­se­quently, the U.S. do­mes­tic oil in­dus­try en­joyed oil prices ap­prox­i­mately dou­ble the world oil price for the du­ra­tion of the quota, which was ended by Pres­i­dent Richard Nixon, who was wor­ried about in­fla­tion and end­ing the need for the Rail­road Com­mis­sion to man­age a mar­ket that faced other fed­er­ally im­posed re­stric­tions, such as price con­trols.

The Rail­road Com­mis­sion’s con­trol of pro­duc­tion “worked,” but only be­cause the U.S. mar­ket was re­ally well-in­su­lated from the for­eign sup­pli­ers. That is not the case to­day.

In con­text, at pre-virus lev­els, the U.S. con­sumed ap­prox­i­mately 18 mil­lion bar­rels per day of crude oil, pro­duced ap­prox­i­mately 12.5 mil­lion bar­rels per day and ex­ported 3 mil­lion bar­rels per day. This does not add up to en­ergy in­de­pen­dence. Texas pro­duced ap­prox­i­mately 4.5 mil­lion bar­rels per day.

Sup­pose the Rail­road Com­mis­sion cuts Texas pro­duc­tion by 25 per­cent. Less pro­duc­tion re­quires fewer work­ers. Mar­ginal pro­duc­ers will sprint to the bankruptcy courts. Of course, fire sales of prop­er­ties to bet­ter-cap­i­tal­ized com­peti­tors will also re­sult, and the job losses will be­come per­ma­nent.

Will the price of oil in Texas in­crease? Un­likely. Even as­sum­ing that the Per­mian play­ers could raise prices, the re­al­ity is that re­fin­ers would still be buy­ing cheaper im­ported oil be­cause that is what they need. The U.S. ex­port mar­ket would lit­er­ally dry up, and the Per­mian pro­duc­ers would have lots of oil they could not move at the higher price.

But world oil con­sump­tion was al­ready down by 800,000 bar­rels per day in the warm­est Jan­u­ary on record. The U.S.-led trade war has re­sulted in less in­ter­na­tional com­merce and less fuel con­sump­tion. Now comes the di­rect im­pact of the virus, at least 500,000 bar­rels per day due to lower air­line con­sump­tion.

Why does this mat­ter in a 100 mil­lion-bar­rel-per-day mar­ket? Our re­search shows that for a 1 per­cent in­crease in quan­tity sup­plied to the mar­ket, the price will fall 25 per­cent. With the Saudis adding oil and de­mand fall­ing — China’s con­sump­tion is dev­as­tated — the sur­plus to­day is much more than 1 per­cent. The price of oil has been in the freefall ev­ery­one ex­pected. And now, no one across the globe has any short-term prospects of fill­ing up their tanks and tak­ing a road trip.

Pres­i­dent Don­ald Trump has her­alded the oil price col­lapse as “good for the con­sumer, gaso­line prices are com­ing down,” and ear­lier likened low oil prices to a tax de­crease. Ev­ery elected of­fi­cial in Wash­ing­ton, D.C., knows ris­ing prices at the pump are poi­son for re-elec­tion.

If the Texas Rail­road Com­mis­sion kow­tows and cuts pro­duc­tion, the com­mis­sion­ers will join the ex­ec­u­tives of Pioneer and Pars­ley in a very special in­famy.

Ed Hirs is an en­ergy fel­low and lec­turer in the De­part­ment of Eco­nomics at the Col­lege of Lib­eral Arts and So­cial Sciences at the Univer­sity of Hous­ton.

Cal­laghan O'Hare / Bloomberg

A row of pump­jacks is seen last year at a Di­a­mond­back En­ergy oil rig in Mid­land. Ex­ec­u­tives from Pioneer and Pars­ley have urged the Rail­road Com­mis­sion to cut pro­duc­tion across Texas.

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