The global oil market is experiencing historic turmoil. The COVID-19 and public health initiatives have caused an historic drop in demand. Many oil and natural gas companies are struggling to survive. This challenge requires a global market management that aims at matching global supply with global demand to prevent a massive decline in investment that might lead to the next energy crisis.
When it comes to COVID-19, governments are talking about “smoothing the curve.” Global oil market management is also about “smoothing the curve” by preventing extreme volatility – which has historically been the goal of oil market management. A lack of management leads to a physical waste of resources, a decline in efficiency, and higher costs. It’s what prompted the formation of large companies that had the sheer size to accomplish market management like Rockefeller’s Standard Oil, and the Seven Sisters including Chevron
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, Exxon, Mobil, along with regulatory bodies like the Texas Railroad Commission (TRRC) and groups like OPEC, and now OPEC+, which are able to prevent extreme volatility, but the market remains competitive within these boundaries.
It shows that even when some oil-producing countries use their market power through OPEC or OPEC+, they still operate competitively within a market management system that focuses on eliminating extreme volatility. Even under such a system, regional markets, like the oil industry in the U.S., operate competitively,
Unfortunately, during this current crisis, there are state regulators in America who are turning to government intervention instead. They want to force all oil and gas companies under their jurisdiction to cut production to the same predetermined level, which is known as prorationing. While there is no “physical waste”, they want to redefine it as “economic waste” to enact regulations that are harmful to the oil and gas industry as a whole.
Texas Oklahoma North Dakota oil production
Anas Alhajji
This strategy is artificially cutting supply, hoping the price of oil will rise. All it really does is put a one-size-fits-all mandate on each company that will inevitably lead to reduced efficiency and increased costs, as producers in Texas argued before the TRRC rejected prorationing.
Prorationing neither reduces volatility nor contributes to price stability. Forcing an equal-percentage cut on everyone except small companies protects inefficient producers from market forces and increases market volatility. The supporters of prorationing in Texas, Oklahoma, and North Dakota aren’t seeking market management, they just want to minimize the pain of certain companies who were afraid that full storage will force them to cut production significantly and more than others with excess to storage. These companies want prorationing to force every producer in their state to cut production so storage will not be as full, and that will enable them to sell more. That is why most companies and trade organizations including the American Petroleum Institute, the Texas Independent Producers & Royalty Owners Association, and the Petroleum Alliance of Oklahoma came out against prorationing.
Prorationing would essentially make companies wards of the state, reducing their innovation. The U.S. is the only country in the world where oil is privately owned, and this private ownership unleashed the innovation that made the shale revolution possible.
While the TRRC and regulators in Oklahoma and North Dakota are legal entities entrusted with managing their oil and gas industries, they do not own the resources. This explains why the TRRC lost every single lawsuit in the early 1930s when it tried to prorate production. After these losses, the governor of Texas declared Martial Law and used the National Guard to enforce these orders. Yet, the claimed success of the TRRC would not have happened without the control of the Seven Sisters that had the size to conduct market management. In fact, the success of the TRRC is really being an extension of the control of the Seven Sisters.
This leads to further problems with enforcement under prorationing. Prorationing requires monitoring and enforcement. None of the Commissions have the financial and technical capabilities to fully implement the order. Oil companies in OPEC+ countries are fully or partially owned by governments, allowing them to easily implement a cut. Market management requires a swing produce with large spare capacity such as Saudi Arabia, which is able to reduce market volatility almost on its own. American shale companies are not swing producers, they’re marginal producers. Swing producers willingly cut production to influence the market. A marginal producer is forced by low oil prices to cut production.
Yet, even if regulators could technically implement proration, they don’t operate on an island. Proration won’t work if neighboring states don’t also implement the strategy. Otherwise, those neighboring states that can produce as much as they want would sell into states that are prorationing, overtaking their market. In this case, proration hurts domestic producers and benefit producers in neighboring states. Such a thing does not happen among OPEC+ members because of the existence of official borders and customs. Saudi Arabia cannot flood Russia domestic oil market, for example.
The argument for proration has nothing to do with market management. It’s about certain companies seeking government intervention to protect them from the pain of this crisis, which will lead to a decline in efficiency and higher costs. While we need a global oil market management, we need regional and local markets that embraces free market principles and allows the sheer size and innovation of the American oil and gas industry to bring much-needed stability.