Of Oil Prices and Government Power
By Pierre Lemieux
Positive economics does not tell us what the price of oil should be, although it does teach much about the factors that determine it. Normative economics or welfare economics suggests that this price should be determined by competitive markets, which will put oil production somewhere on society’s production possibility frontier (PPF). This way, as much of oil as possible will be produced given the production of all other goods and services. In a competitive economy (starting from an initial distribution), the combination price-quantity on the PPF will be determined by consumer preferences and costs of production, the latter incorporating the preferences of the producers themselves.
A less strictly neo-classical, more Austrian approach would emphasize the coordinating function of oil prices as well as the market process that leads to efficiency.
Perhaps the most important result of economic theorizing is negative. Applied to oil, it is that nobody, including government planners, can know what should be the price of oil. Nobody knows enough to intervene coercively and efficiently in the market. Coercive interveners will only impose their own personal preferences and values. These preferences and values will typically be redistributive—that is, they will aim at redistributing money or power in favor of those making or influencing the intervention.
This is illustrated by President Donald Trump’s reasons for trying to influence oil prices: to satisfy the demands of his electoral clientele (or at least what he believes these demands are in view of the trade-offs they imply). In the debate around the assassination of journalist Jamal Khashoggi, an immigrant resident of the United States, apparently by agents of the Saudi Arabian government, President Trump wants to spare Saudi Crown Prince Mohammed bin Salman because he believes that the latter can help him keep the oil price in check. In the official White House statement of November 20 explaining why he is “standing with Saudi Arabia,” the president said:
After the United States, Saudi Arabia is the largest oil producing nation in the world. They have worked closely with us and have been very responsive to my requests to keeping oil prices at reasonable levels – so important for the world.
The Wall Street Journal (“Trump Stands With Saudi Arabia, Plays Down Crown Prince’s Alleged Role in Journalist Killing,” November 21, 2018) reports that the president also said, speaking about the Saudi Arabian government:
If we broke with them, I think your oil prices would go through the roof.
On November 21, he tweeted:
Oil prices getting lower. Great! Like a big Tax Cut for America and the World. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!
What exactly is the influence of the Saudi Arabian government on oil prices is uncertain. The country accounts for 12.9% of world oil production, which is an important market share but certainly not enough for its rulers to decide the price. Even the OPEC cartel, on which Saudi Arabia exerts a weighty influence, is far from controlling all world production with its share of 42.8%.
To the extent that the U.S. administration is able to influence oil prices downward by cajoling or bullying the Saudi Arabian government, it harms American shale drillers who have been responsible for the doubling of American oil production over the past 10 years. American production now accounts for 14.1% of the world total. (A convenient source for oil statistics is the annual BP Statistical Review of World Energy; my figures are borrowed from the 2018 edition.)
Speaking of American shale drillers, the Wall Street Journal writes (“Frackers’ Growth Ambitions Clouded by Drop in Oil Prices,” November 21, 2018):
While current oil prices aren’t low enough for companies to put off fracking wells near-term, sustained lower prices could prompt companies to dial back next year’s capital spending plans.
It is true that, in a free economy, consumers are more important than producers: the former are “sovereign” as economists used to say. But this assumes that the economy is free and that the government does not set prices. In a free economy, there is no more reason and no more power to harm producers than to harm consumers. Note also that, in a free society, national security does not justify the government to intervene anywhere it wants.
One could argue that the influence of the OPEC government cartel on world oil prices, whatever its exact extent, introduces a monopoly element that distorts the free market. Although this is true, a price manipulation by the U.S. government that actively discourages competition by American shale drillers in the name of (domestic and foreign) political reasons only strengthens OPEC’s oil cartel. The U.S. government’s policy should be to leave alone whatever free market there is—and the American frackers are a mighty part of this free market.
Otherwise, the American state is becoming more of an “adversary state,” as Anthony de Jasay calls the state that chooses to harm some citizens in order to benefit others. This is in opposition to the neutral “capitalist state,” in de Jasay’s terminology. It is not because other people are not free in the world, that the U.S. government should retaliate by subjecting Americans.
I have argued that oil prices will likely continue their secular decline (see “Cheaper Oil Cannot Hurt the Economy,” Regulation, Spring 2015; this article also explains what a PPF is.) But even if I am wrong, this would not justify the U.S. government to intervene. Needless to say, this conclusion does not depend on who or which political party is in power.