The oil-price collapse associated with the coronavirus pandemic has elicited political proposals for relief, put forward by some in the upstream industry and by the Trump Administration itself. “All options are on the table,” stated U.S. Secretary of Energy Dan Brouillette on April 6.
Besides the most obvious objective of containing the coronavirus and restarting our economy, what policies can actually work to restore a functioning market? And what measures come at the expense of necessary industry adjustment, not to mention consumers and taxpayers?
Of the numerous options discussed for the relief of upstream oil, most involve a level of federal or state activism that may, in fact, be harmful to the domestic industry in the long run. Let’s evaluate them one by one:
Following weeks of direct and media diplomacy by President Trump, including the threat of import tariffs, OPEC and its allies have finalized an agreement to cut production after talks on April 12. The OPEC+ group will reduce their supply by 9.7 million barrels per day in May and June, ease the cuts to 7.7 million barrels between July and December 2020, and then to 5.8 million beginning in January 2021.
“We write urging you to initiate a Section 232 investigation into the excessive dumping of crude oil by the Kingdom of Saudi Arabia and the Russian Federation,” U.S. Senator James Inhofe (R-Ok) wrote to Commerce Secretary Wilbur Ross on March 18, 2020.
As you know, the global oil market is in disarray in large part as a result of the recent actions taken by Saudi Arabia and Russia to flood the oil market with an unprecedented supply of crude. The manipulation of markets has roiled the economy, causing severe trauma to the American energy industry. It is essential that the American government respond with swift, decisive action.
Section 232 of the Trade Expansion Act of 1962 permits the Secretary of Commerce to make a “national security” finding and recommend to the President to “adjust the imports of an article and its derivatives,” or take non-trade actions to the same end.
History rhymes. Beginning in the late 1920s, Oklahoma, Texas, and other oil states (but not geographically isolated California) limited state production to a regulatorily determined “market demand.” This “quest for stability,” as one historian put it, was exacerbated by falling demand during the Great Depression.
World War II temporarily ended state proration. But with the return of an oil surplus in 1947, decades of major cutbacks (as much as 70 percent per well) ensued, coordinated by the Interstate Oil Compact Commission (now Interstate Oil and Gas Compact Commission). With oil shortages in the 1970s, “allowables” were set at 100 percent to leave wells at full production where they have remained for decades.
Later today, the Texas Railroad Commission is considering a proposal to unilaterally prorate production across the state. Maximum allowables would be set per field and per well in the field, and high-cost, low-output wells likely would be exempted (as in the old days). But would the Oklahoma Corporation Commission follow? The Louisiana Department of Natural Resources? The Kansas State Corporation Commission? And what about the relative upstart North Dakota Department of Mineral Resources, which has never had to prorate its oil wells?
Any mandate by one state will create incentives to “cheat” and to “game” proration within and between oil states. If the rules are not uniform, expect the cartel to leak and political fissures to emerge. If history is a guide, mandatory proration should be avoided to let the market consolidate toward fewer, stronger, even integrated, firms better able to hedge prices and time production to market demand.
Oil Tariffs or Quotas
Assuming that the oil states acted as one to effectively limit production to increase prices, the result would be, seemingly, higher U.S. prices insulated from (lower) world prices. But imports would surge to fill the gap, as occurred during the 1950s, leading to the Mandatory Oil Import Program (1959–1973). As a net oil importer, the U.S. created a state/federal cartel.
President Trump has threatened to impose tariffs on imported oil to “protect” the domestic industry. But unlike before, the U.S. ships more crude oil abroad than is imported. To the extent that a new tariff by Trump blocks foreign oil that otherwise would have entered the U.S., that supply would compete against markets previously served by our exports, lowering prices in the process.
Domestic producers, in other words, would not gain high prices, although individual situations might help some and hurt others in disproportionate ways. Instead, the market would be left with the inefficiencies of government-created rearranged trading patterns.
Pursuant to the Deep Water Royalty Relief Act of 1995, the Minerals Management Service of the U.S. Department of Interior can, and perhaps should, adjust royalty rates for offshore oil (and natural gas) production in federal waters in situations of potential shut-in’s and lost payments to the U.S. Treasury. But a far broader type of relief is being proposed in response to the pandemic.
“The independent offshore oil and gas companies are not asking for a bailout,” wrote Louisiana’s two Senators to President Trump. “Instead, they are asking … for three temporary relief measures:
- Grant a suspension on the payment of all royalties on oil and gas produced in the Federal waters of the Gulf of Mexico by or on behalf of independent oil and gas companies until twelve months after the World Health Organization removes the pandemic declaration.
- Direct suspensions of operation and production for Federal offshore leases for the same time period.
- Grant an automatic three-year extension for the primary lease terms of offshore oil and gas leases.
A blanket royalty suspension, short of a pandemic-directed cessation of offshore operations, is a treatment that goes well beyond the statutory authority of existing law.
SPR Oil Purchase
A stop-gap measure to help independent producers—federal oil purchases to fill the Strategic Petroleum Reserve (SPR)—was removed from consideration in what became the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The Trump administration had requested $3 billion to buy up to 77 million barrels “from small to medium size American energy companies.”
More recently, the Administration announced intent to make a special purchase of 30 million barrels using other budgetary means. And most recently, a group of Texas congressmen announced legislation for the original $3 billion to fill the reserve to capacity.
Whatever the outcome, any purchase represents a stop-gap subsidy to sellers at the expense of taxpayers, although it would arguably be a much smaller hit given the current low prices for crude.
Renting storage in the Strategic Petroleum Reserve is arguably the most market conforming proposal of all the ones described here. SPR rental allows the private sector to meet an urgent need at a time of lost demand and historically low prices. The U.S. Treasury would receive revenue that it would not otherwise. The win-win allows as much as 77 million barrels to be furloughed for withdrawal and later sale. It also avoids taxpayer-funded purchases for the same capacity in the Reserve.
Renting space creates a precedent that can lead to more liberalization in the future. It is a step in the direction of partial or total privatization, where the government would lease space and/or sell oil without recourse to expand private entrepreneurship.
Government grows in emergency situations and leaves a residue of intervention after the emergency is over. With oil, as with other commodities, World War I planning set a precedent for New Deal intervention, and both set the stage of World War II’s price controls, allocation controls, production edicts, and special subsidies.
The current pandemic risks this “ratchet effect,” as described by Robert Higgs in Crisis and Leviathan: Critical Episodes in the Growth of American Government (1987). Great caution must be exercised by lawmakers in this regard. The OPEC+ announcement of production cuts has resulted from President Trump’s diplomatic efforts. Ideally, this will satiate domestic concerns, stave off the risk of more interventionist policies, and allow us to focus on the key issue at hand: stopping the coronavirus and getting the world economy back in motion.