Production Quotas:  A Policy Cure Worse than the Disease?

For decades, the United States has feared a production quota from the Organization of Petroleum Exporting Countries (OPEC) that could drive up the global price of oil and spark a recession at home. Historically, recessions in the U.S. have been preceded by a run up in the price of oil. Now, in a strange reversal, the Trump Administration is in negotiations with OPEC and Russia to set the same policy we once feared: a production quota aimed at increasing the price of oil.

What’s changed? The U.S. became a net exporter of oil and gas, and the industry has become an increasingly large part of the U.S. economy. While the U.S. has always had a domestic oil industry, the U.S. became a net importer of oil beginning in the middle of the 20th century. The U.S. feared a high price of oil since it bought much more oil than it produced.

Beginning in the early 2000s, the U.S. energy landscaped dramatically changed. The technological advances in seismic mapping, horizontal drilling and hydraulic fracturing changed the trajectory of U.S. energy, making the U.S. a net exporter of crude oil and petroleum products in 2019. These technological advances also made the oil and gas industry an even more important part of the economy. The American Petroleum Institute estimates the industry supports 10.3 million jobs and close to 8% of the U.S. GDP. Too low a price of oil could now upend a major part of the U.S. economy.

President Trump recently met with U.S. oil companies and hopes to negotiate a deal to cut back on oil production for both the U.S. and countries aligned with OPEC like Russia. But there are a number of foreign policy challenges that make such a deal unlikely. Even if a deal could be achieved, it threatens the free market policies that have enabled the oil and gas industry to be so successful here in the U.S.

President Trump is negotiating with leaders of countries who don’t particularly want a deal. Russia especially desires to harm the U.S. oil and gas industry, and Saudi Arabia does not mind if it is harmed either. Both countries have larger conventional reserves of oil and gas compared to the U.S., which produces much of its oil from unconventional reserves such as fracking for shale oil. Shale oil is more expensive to produce, so a lower price of oil disproportionally harms U.S. producers compared to those in Russia and Saudi Arabia. Many US producers need an oil price of $50 or $60 a barrel to break even whereas Saudi Arabia and Russia can break even at a lower price per barrel. Both Saudi Arabia and Russia also have significant cash reserves to keep their governments afloat during a time of lower oil prices.

Additionally, Russia’s uses its supply of natural gas – and the threat to take it away – as a tool to exert political influence in Europe. President Putin cares more about the long-term political power of Russia’s oil and gas industry than he does about a short-term loss of profits.

It is also unclear how a production mandate would work in the U.S. The U.S. is one of the only countries in the world that has subsurface mineral rights and a largely private oil and gas industry. Most of the OPEC member countries have nationalized oil industries. Throughout most of the world, oil industries are nationalized or heavily controlled. In Russia, for example, private ownership is nominal, and President Putin exerts enormous influence. These countries directly control production.

The federal government does lease land for drilling, most significantly offshore in the Gulf of Mexico, and President Trump has suggested mandating a shutdown of oil production in the region as a way to cut production. But a moratorium on leasing or drilling in the gulf or on all federal land would set a dangerous precedent.

The federal government has historically leased federal lands for energy production with few restrictions. The goal has been to increase domestic energy production, create jobs and generate royalties for the federal government. Deviating from these goals risks setting the precedent for future administrations to do the same. On the campaign trail this year, the majority of Democratic presidential candidates said they would ban oil and gas drilling on federal lands.

Most importantly, President Trump should let the market respond to the change in the quantity of oil demanded and corresponding price drop. Market prices already signal to businesses to produce less oil. Moreover, consumers benefit from lower oil prices through the reduced  cost of transporting goods. A government restriction on production risks an overcorrection and sets the precedent of mixing politics into businesses decisions.

In Depth: Energy

It is difficult – and perhaps even impossible – to overstate the relationship between readily available access to safe, affordable and reliable energy and individual prosperity and economic wellbeing. This is because energy is an input to virtually everything we produce, consume and enjoy in society. Think for a minute…

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