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Benjamin Zycher: Where We are Headed: Making the U.S. Poorer and OPEC+ Richer

Why international competitors are eating the U.S.'s lunch in oil markets. The light at the end of the COVID tunnel is brightening, in substantial part as a result of the global inoculation effort, however slowly and unevenly. With this improving public-health outlook comes a prospective renewal of worldwide economic growth generally, and in industrial, commercial, and transportation sectors in particular. That would engender an expansion in the demand for fossil fuels; do not kid yourself that unconventional energy can satisfy that demand shift at competitive costs either now or over the foreseeable future. That is why it cannot survive without massive subsidies.

The reality of an ongoing increase in the demand for fossil fuels is obvious, as reflected in the announcement early this month by OPEC+ that its oil production will be increased by a total of 1.15 million barrels per day from May through July. The production of fossil fuels in any given economy represents, literally, the transformation of indigenous natural resources into increased national wealth. When realized, competitive market forces will tend to allocate it among capital investors, workers, suppliers, and myriad others in accordance with perceived contributions to that wealth expansion.

Certainly, perspectives differ among the OPEC+ members on the rate of demand growth, on competitive conditions, on the appropriate timing of increased production, and thus on the most profitable choice among available output and pricing strategies. But the central perception of strengthening demand conditions is incontrovertible, and the OPEC+ membership sees no reason to deny itself the additional wealth attendant upon a production increase in response to improving market conditions.

Nor is there a good reason that the U.S. should engage in mindless economic sacrifice. But that is not the debate in which we are engaged. Instead, the Biden administration and its allies in Congress, together with climate-policy extremists, are searching for rationales to justify restrictions or bans on new lease sales on federal lands, a self-defeating increase in the royalty rate on production from such leases, disapprovals or restrictions on investments in pipelines and other fossil energy infrastructure, a deeply dubious tightening of methane emissions standards, and a general shift away from fossil fuels in favor of an energy system producing "net-zero" greenhouse-gas emissions by 2050.

The various news reports on the OPEC+ announcement shared a common theme: "The market was more or less expecting a rollover of the current cuts or just a slight increase." The announcement instead of the substantially larger production increase is more interesting than observers seem to recognize, in particular given resistance by the Saudis, who have argued that "the glory days of U.S. shale… are never coming back." (The Saudi Energy Minister: "Drill, baby, drill is gone forever.") But why should that be a reasonable expectation? The rollout and efficacy of the COVID vaccines — whatever the bumps in the road that have been encountered — have been broadly expected for months, and the ensuing increases in economic growth and energy demand are obvious.

It is not difficult to hypothesize that the OPEC+ producers have concluded that prospective competition from U.S. oil producers will prove less important than was the case during the Trump administration, due far more to political constraints on expanded U.S. production than any inherent reluctance to produce on the part of U.S. oil companies. In other words, the clear animosity of the current governing majority toward fossil energy, which was made very clear early in the campaign (and, of course, has been reflected in deeds as well as words) since President Biden took office), is likely to have led OPEC+ to conclude that they can grab market share with less fear of a sharp price decline from increased in U.S. production.

After all, the Saudi argument that "the glory days of U.S. shale… are never coming back" would make little sense otherwise. There is no reason to believe that U.S. producers systematically have weaker foresight with respect to the evolution of market conditions than anyone else. Moreover, because the production and consumption of fossil fuel reserves are "substitutable" over time (they can take place during the current time period or during a future one), the market price today is the competitive expectation of the future price, on the basis of all available information.

Accordingly, U.S. producers can form expectations and make plans just as rationally as any others. They know that prices can be volatile, that they can be depressed by unexpected events (e.g., COVID), that OPEC+ can increase output unexpectedly. Those realities were just as true before the pandemic as after. All producers must make judgments about the long-term "steady-state" price and the efficiency of investments at that price.

The real question is whether U.S. policies will ratify the strong OPEC+ preference that competition from U.S. producers be suppressed artificially. Any such suppression would reduce U.S. national wealth and increase that of foreign producers. And for what? Were the Biden net-zero policy to be implemented immediately, the effect on global temperatures in 2100 would be 0.104 degrees C (using the Environmental Protection Agency climate model), an impact that would not be detectable given the natural variation in temperatures. (The entire Paris Agreement if implemented immediately, would reduce global temperatures by 0.17 degrees C by 2100.) The reality is that the crusade against fossil fuels — the effort to make the U.S. poorer in favor of others — has nothing to do with environmental quality. It is wholly an ideological imperative, not a very convincing rationale for imposing losses upon Americans.

Benjamin Zycher is a resident scholar at the American Enterprise Institute.

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Posted: April 15, 2021 Thursday 06:30 AM