Samuel Johnson on OPEC

Samuel Johnson and then Oscar Wilde observed that second marriages are a triumph of hope over experience. That observation can also be applied to OPEC agreements to cut production.

The history of OPEC agreements on production quotas is that they haven’t lasted much longer than it took for the ink on them to dry. The reason is quite simple. As long as member nations have spare production capacity, they have a strong financial incentive to cheat. Saudi Arabia in the past has been the swing producer and its reductions in production have been offset by other members cheating and increasing theirs. As long as demand exceeds supply and some OPEC member can increase its production, that will continue to be the case.

Earlier this week, oil markets firmed up for a brief time when it was reported that OPEC had reached an agreement to reduce production from around 33.2 million barrels a day. Then reality set in and markets slipped back down.

Agreeing that production should be reduced is different from agreeing on  the size of a reduction and how it will be allocated. It is highly unlikely that Saudi Arabia will agree to a reduction as long as Iran is pushing to increase its production to at least 4 million barrels a day. The Wall Street Journal recently reported that Iran’s “ability to reach pre-sanction levels above four million barrels a day is now in question. Iran has been pumping 3.85 million barrels a day.” but IEA has reported that Iranian production had slipped back to 3.6 million barrels a day.  What Iran can do in the near term is not at all clear.

There also have been reports that with Libya and Nigeria production recovering, actual OPEC production could be 1 million barrels above the suggested range of 32.5 to 33 million barrels.

So, where will cuts come from and how will they be enforced? Those two questions have bedeviled past agreements and in the end OPEC agreements have turned out to be triumphs of hope.   In the current situation, it appears that most members are producing at or near capacity, so the ability to cheat this time may be constrained, unless Libya and Nigeria can substantially increase theirs. In addition,the proposed reduction is not large–2% at most–, so it is unclear how much impact it would have on price?  In reality, the impact is likely to be small at best.

What is different today is US production, enhanced by “fracking” and horizontal drilling. Shale oil producers have been able to withstand the price reduction better than had been estimated, so any reduction by OPEC will be offset by increased domestic production.

This time hope will triumph and the US economy benefits if it is.

Letting Markets Work

On September 12, Colonial Pipeline, which supplies gasoline and other petroleum products from Texas to New York, was shut down because of a leak. The leaking line supplies about 1.4 million barrels/ day to states from Tennessee to New Jersey.

The shutdown had a noticeable impact on gasoline supplies from Georgia to Virginia with spot outages reported in some states. The governors of those states were quick to make state of emergency declarations, which had the primary effect being to relax constraints on hours of work by tank truck drivers and restrictions on tanker truck size. The Governors also made obligatory political statements about not tolerating price gouging, an ill-defined concept.

The media as expected focused on price increases and stations that ran short of gasoline without giving much coverage to alternative sources of supply that minimized the disruption caused by the shutdown.

Suppliers of gasoline reacted by moving more gasoline by waterborne tankers to ports along the east coast and then using tanker trucks to resupply affected areas. Colonial also began to utilize a second pipeline that typically moved distillate fuel. Gasoline suppliers had a strong incentive to reallocate supplies from other areas to minimize shortages because of they were losing sales revenue from the pipeline shutdown.

Anytime there is a shortage of any product, its price increases. That is how supply and demand works. Price increases do two things. First, they bring demand in line with available supplies and second they create an incentive to increase. For those two reasons, railing against prospective “price gouging” is not in the consumers’ best interest.

The history of price and allocation controls in the 1970s demonstrates that when government attempts to manage markets, it makes problems worse and they last longer. Then drivers had to search for stations that had supplies, often relying on word of mouth or media reports. Today, information technology and a 24 hour news cycle allows motorists to quickly find stations and areas with available supplies.

Governors apparently had learned the lesson of the 70s and avoided the “do something” overreaction while letting markets work. The lesson for the future is that the best course of action for officials and the media is to inform the public with complete and accurate facts, the actions being taken to mitigate adverse impacts, avoiding political rhetoric, and giving market forces a chance to work.

 

 

 

 

 

Yogi Berra’s Carbon Tax Advice

Yogi Berra once observed, “In theory there is no difference between theory and practice. In practice there is”. Academic analyses often ignore this wisdom because of oversimplified assumptions and a failure to adequately address real world complexity. Such is the case with an article in the September 14 Wall Street Journal—The Coming Price on Carbon by Amy Meyers Jaffe ( University of California, Davis).

The crux of her argument is that the complexity of increasing regulations aimed at carbon is leading companies to move toward a carbon tax because business places a high value on transparency and predictability. If the choice, ignoring for a moment the scientific issue, was a carbon tax or a series of regulations, the answer is straightforward. But, anyone who thinks that by embracing a carbon tax will save them from more regulation is related to Rip Van Winkle.

The Obama Administration and its environmental allies have been pursuing a strategy of increasing complex carbon related regulations as a way to get companies to beg for a carbon tax. Ms. Jaffe might be right that we are at a tipping point on this issue. If so, business might lobby aggressively for a carbon tax, get it and still be saddled with more regulations. The Obama Administration and environmental zealots have been waging a war on fossil fuels and business conceding a carbon tax will just embolden them more. They will only be satisfied when fossil energy is like whale oil, a thing of the past.

Contrary to the assertion in Ms. Jaffe’s article that “some sort of carbon price is needed because emissions have costs” there has been a de-facto price on carbon since the first Clean Air Act in 1970. Constraints on pollution related emissions have imposed costs on fossil fuels. As regulations became more stringent, environmentalists hoped or believed that coal, oil, and gas would be priced out of the market. They seem to have won on coal, but not in other countries. Petroleum based fuels have withstood the regulatory onslaught because oil is abundant, versatile, has high energy density, and is cost-effective relative to alternatives, in spite of their generous subsidies. A carbon tax would add to the cost currently being borne by carbon fuels, not reduce or replace any of them. And, that is the Achilles heal in carbon tax logic. There is no trade-off to be realized.

The case for putting a price on carbon is also based on the assertion that “technological advances have made it cheaper to move away from carbon emitting technologies. While it is true that the cost of producing solar cells and lithium ion batteries has been declining, it is not true that wind, solar, or electric vehicles are cost competitive with fossil energy. The apparent competiveness is based on tax credits and subsidies. Take away the subsidies and government bestowed incentives and the demand for alternatives would dry up. It is also misleading to imply that these alternatives are replacements for carbon. What happens when the wind doesn’t blow and the sun doesn’t shine? Coal or natural gas powered electricity. Germany, which is a leader in promoting alternatives to fossil fuels, has an electricity price about 3 times greater than the US average and has been turning back to coal to compensate for the lack of storage technology and periods when the sun doesn’t shine.

As documented in the George C. Marshall Institute report, A Skeptical Look at the Carbon Tax, a carbon tax, like Clinton’s BTU tax, faces a host of practical problems. The support that Ms. Jaffe sees comes from a coalition of “Bootleggers-and-Baptists” comprised of environmentalists, corporate rent seekers, and government dependents “who will be actively involved in designing its provisions in ways that benefit special interests, undercut any beneficial effects and accentuate its harmful side effects”. And, judging from past experience, a carbon tax will not substitute for other taxes or improve their efficiency, nor will it be implemented without political favoritism. It will be complex and become the equivalent of an ATM for Congress to increase spending.

Ms. Jaffe’s article is based on the assumption that human activities are the dominant cause of climate change. The theory of human induced climate change has not been demonstrated by scientific validation. It is a creation of climate models that have been constructed to create a self-fulfilling prophecy, which they do. The pattern of climate change over human history and the last 100 years is inconsistent with the assertion that increasing CO2 has lead to increasing temperatures since the end of the Little Ice Age. The recent pause/hiatus in warming is also inconsistent with climate orthodoxy. While advocates who claim that the science is settled use the IPCC science assessments as their foundation, they conveniently ignore the list of major uncertainties cited by the IPCC and its gradual reduction in estimated climate sensitivity.

Business and environmentalists may eventually get their desired carbon tax and if they do they will discover that Yogi Berra was right—in the real world there is indeed a difference between theory and practice. They will have been willingly snookered.