Prices fluctuate continuously – they rise, they fall, and they find equilibrium time and again. This cycle is the essence of supply and demand working together within the market.
When a product’s supply exceeds its demand, prices will decrease. Conversely, if the demand outpaces supply, prices will increase. Producers effectively respond to these price changes by adjusting their output: rising prices signal them to boost production, while falling prices indicate a need to reduce it.
This fundamental principle illustrates how markets efficiently distribute goods and services. Unlike command economies that rely on five-year plans or rigid pricing systems, open-market pricing provides a more effective mechanism. However, not all markets function equally; for example, the dynamics of gumballs and garbage bags are far less complex than those of solar panels or jet engines.
What we observe is that certain markets face more governmental intervention, particularly when significant resources are at stake. Occasionally, governments nationalize entire sectors in the name of public welfare, which raises its own set of concerns.
Peculiar shifts in prices can often suggest that factors beyond natural supply and demand are at play. For instance, on April 6, a barrel of West Texas Intermediate (WTI) crude oil was priced at approximately $62. Just ten months prior, it was around $43, and two years ago, it hovered near $30.
As of April 26, WTI oil surged to about $68 per barrel. What could be the cause of such volatility?
Price Fixing Incidents
The oil market, influenced by extensive governmental involvement globally, is susceptible to price distortions caused by this interference. Numerous factors contribute to oil pricing, and although it’s complex, seeking understanding remains crucial.
The oil and gas sector exhibits notable cyclical behavior, characterized by dramatic fluctuations in both production and consumption. Adding to its complexity is intervention from the Organization of Petroleum Exporting Countries (OPEC), a cartel of 14 nations that often collaborates with Russia to manipulate oil prices to their benefit.
The significant drop in oil prices in 2015 was largely due to OPEC increasing production, ostensibly to undermine U.S. shale oil producers. At that time, OPEC members could extract oil profitably at lower costs than their U.S. counterparts. The intention behind OPEC’s strategy was to drive U.S. shale suppliers out of the market and maintain their dominance over global oil pricing.
Initially, this approach seemed to work as it inflicted severe damage on U.S. shale producers. However, it also inadvertently harmed OPEC members, notably Venezuela, where the collapse of oil prices led to economic ruin. The ensuing crisis significantly impaired Venezuela’s capacity to sustain its oil operations, resulting in staggering drops in production.
Factors such as debt, insufficient maintenance, lack of investment, and an exodus of skilled engineers have compounded Venezuela’s problems. While the repercussions of OPEC’s price manipulation were most glaring in Venezuela, other member countries similarly pressured oil revenues. Hence, by the end of 2016, OPEC and Russia agreed to reduce production in a bid to elevate oil prices.
The Oil Curse Arrives in Washington
OPEC and Russia may have miscalculated dangerously; their price manipulation resulted in unforeseen consequences. By early 2018, oil prices had surpassed $60 per barrel and are now precariously close to $70.
This escalation in oil pricing, a product of OPEC’s and Russia’s efforts, has granted U.S. shale producers a substantial opportunity. With prices above $50 per barrel, U.S. shale producers can break even, and at over $65, they can enjoy significant profits.
Moreover, with prices at advantageous levels, U.S. shale producers secured these rates through strategic hedging in long-term futures contracts. This foundation has allowed them to ramp up production to over 10 million barrels per day for the first time since 1970. Consequently, OPEC and Russia are compelled to reconsider their production cuts.
Yet, as U.S. shale producers enjoy their newfound profitability, OPEC may increasingly lose its grip on global oil prices. The long-term implications could be substantial, with U.S. crude production poised to surpass that of Saudi Arabia, potentially rivaling Russia in the near future.
The surge in U.S. oil exports is evident; in fact, last week saw an average of 2.3 million barrels per day, a record high.
While this growth appears beneficial for the U.S., it raises crucial questions. Will America’s rise as the leading oil producer bring prosperity or peril?
Numerous resource-rich nations have encountered difficulties stemming from vast oil discoveries and production, often leading to dependency on volatile oil revenues that result in corruption and instability.
Given the size of the U.S. economy, the increase in oil production may not significantly drive the entire economy. Yet, there are concerns that the government may struggle to manage this newfound wealth.
Will Washington utilize its share of this shale oil bounty to decrease national debt? Will it address unfunded liabilities while strategically reducing government dependency?
Or perhaps the government will see this wealth as a justification for greater spending, leading to deeper debts and expanding its influence globally?
History suggests that the likely outcome may not be favorable.
Sincerely,
MN Gordon
for Economic Prism
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