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LRB, Vol. 39 No. 11 · 1 June 2017
Buckle Up!
by Tim Barker
Crude Volatility: The History and the Future of Boom-Bust Oil Prices by
Robert McNally
Columbia, 300 pp, £27.95, January, ISBN 978 0 231 17814 3
When Donald Trump nominated Rex Tillerson, the CEO of Exxon, as
secretary of state, Robert McNally found the choice unremarkable. ‘The
closest thing we have to a secretary of state outside government is the
CEO of Exxon,’ he said. McNally is an energy consultant, a former
adviser to George W. Bush, Mitt Romney and Marco Rubio, and a member of
the National Petroleum Council.
Crude Volatility would be a good title for a biography of Trump, but
McNally’s book was written before the election and studiously avoids
political controversy. The book expands on a pair of articles (written
with Michael Levi) in Foreign Affairs, which argued that recent
fluctuations in the price of oil marked the end of a period of relative
stability that began in the late 1970s. The first piece ran in 2011,
when the yearly average price of Brent crude exceeded $100 for the first
time. The follow up, ‘Vindicating Volatility’, came in late 2014, after
three years of relatively stable prices had given way to a new price
collapse. The book, which appeared in January when prices were around
$55 a barrel, gives a deeper historical exposition of McNally’s (so far
valid) forecast of persistent price volatility.
Since drillers in Pennsylvania first struck ‘rock oil’ in 1859, the uses
of petroleum have shifted – illumination, electricity, heating, machine
lubrication, fuel for internal combustion engines – but through it all,
market forces by themselves have been unable to bring supply and demand
into balance at a stable price level. This is unusual. If a blight makes
tomatoes, say, harder to come by, tomatoes will be more expensive and
consumers will demand fewer of them and buy other kinds of produce
instead. If farmers overestimate the popularity of tomatoes they will
grow too many and the price will fall, leading some farmers to stop
supplying tomatoes and start growing something else. Either way, the
market for tomatoes will find an equilibrium, a price level at which no
producer willing to accept the going rate will be left with unsold
produce and no buyer willing to pay the going rate will find empty shelves.
In the case of oil, however, both demand and supply are unusually
unresponsive (inelastic) to changes in price. Oil is too important and
difficult to replace for a rise in price to cause a fall in consumption.
And if prices fall, the relatively low cost of continuing to run
existing wells (as opposed to the stupendously high costs of bringing
new oilfields on line) means that supply won’t immediately fall far
enough to bring prices back up. But both supply and demand can have
long-term consequences: oversupply may continue because of the
completion of drilling projects begun in times of scarcity, or demand
may begin to lag after a boom because consumers have gradually responded
to high prices with ways of permanently replacing oil – as happened in
the US in the 1970s, when oil was replaced as a source of electricity by
natural gas, coal and nuclear power. This instability is frustrating for
producers, who by themselves are powerless to control supply in response
to price fluctuations. But if many sellers co-ordinate their actions
(either because of voluntary collusion or imposed constraints) they do
have the power to administer stable prices where the market cannot.
The bulk of McNally’s book tells the history of the oil business as a
series of such attempts to control supply. These efforts, he argues,
have been successful enough to make us forget that stable oil prices are
unnatural and can’t be counted on. They can be maintained only through
painstaking and ultimately unsustainable co-ordination between
businesses and governments. In 1931, as global depression took hold and
prices fell, the governor of Oklahoma shut down oil wells by military
force, declaring that ‘the price of oil must go to $1 a barrel; now
don’t ask me any more damned questions.’ Price stability grows from the
barrel of a gun, not the ministrations of the invisible hand. But
precisely because the project is so political, it is also fragile.
McNally argues that we have become used to price co-ordination over the
past century, but that era is now at an end. No single actor – not even
the king of Saudi Arabia – is today powerful enough to exert the kind of
control once enforced by the Oklahoma governor.
Oil – the compacted remains of prehistoric life – has always oozed to
ground level, and people have always found something to do with it:
caulking their canoes, painting their faces, lubricating their tools. In
the 1860s, whale oil became too expensive to use as a source of light,
and start-up hucksters in Pennsylvania discovered they could pump oil
out of the ground in greater volumes than anyone expected. As the market
grew rapidly, the industry developed a tendency towards overproduction.
With a growing economy, demand would surge and prices would go up,
leading wildcat drillers to flood into the oil regions; oversupply would
lead to price collapses and ruin the men who had sunk everything they
had into pressurised wells and pumps. In the thick of this
entrepreneurial swamp, John D. Rockefeller recognised that in a free
market, voluntary co-operation would always give way to ruinous
competition. Assiduously, Rockefeller and his Standard Oil trust
integrated the chaotic functions of the oil business, and struck deals
with the railroad companies that brought oil from the fields to market.
In doing so, they did great violence to the ideal of free competition,
but also rationalised the industry so that it could supply fuel at
stable prices.
McNally, following such business historians as Ron Chernow, argues that
Rockefeller’s market power led not only to stable prices but to
consumer-friendly bargains. The public wasn’t so charitable at the time,
however, and anti-monopoly resentment meant the break-up of Standard Oil
and the transition to a period of competitive volatility. This
interregnum came to an end in the 1930s, when the stakeholders in
Oklahoma and Texas – Pennsylvania’s successors as the centre of American
oil production – established legally enforced production quotas limiting
production under the aegis of the Texas Railroad Commission. New
oilfield discoveries in the Middle East were integrated into the Texas
regime of price control when the dominant companies, known as the Seven
Sisters, signed favourable concession deals with the emergent
postcolonial states.
The Texas cartel reached the highpoint of its control over global oil
production in the 1950s. But triumph quickly led to overreach when the
world-bestriding conglomerates tried to impose a punitive price
reduction on Middle Eastern and Venezuelan oil. Iran, Iraq, Kuwait,
Saudi Arabia and Venezuela formed Opec – a global cartel of oil
producing nations self-consciously modelled on the Texas Railroad
Commission (even employing former TRC consultants on retainer). They
began to experiment with production agreements and export quotas. When
the United States set itself at odds with Arab nations in the 1973 Yom
Kippur War, Opec responded with an embargo that marked the end of the
Texas era of oil stability and introduced a new system of supply control
on an even greater scale.
In the context of the broader economic dislocations following 1973,
Opec’s assertion of power seemed definitive. But commodity
anti-imperialism was a paper tiger. In the long run, Opec couldn’t force
people to sell at high prices, or stop new oilfields being discovered in
parts of the world that weren’t subject to their agreements. The key to
controlling world oil prices, McNally insists, was spare capacity:
control over existing oilfields that could be brought on line when
demand rose and shuttered when demand fell. At one point, Rockefeller’s
Standard Oil had occupied this role; in the Opec era, Saudi Arabia did
its best. But the role of swing producer exacts serious costs. You have
to be willing to buy dear and sell cheap, because the whole system
depends on your countervailing pricing. Ultimately, the vagaries of
demand and the constant discovery of new oilfields meant that no single
country was willing or able to be the swing supplier. And so, according
to McNally, the long exception of stable, administered oil prices has
come to an end. Opec, so unsettling to Americans in the 1970s, is now
powerless to control the dramatic fluctuations – from $147.27 on 11 July
2008 to $30.28 on 23 December 2008 – characteristic of the new oil
market. We have come to inhabit, McNally concludes, the first free
market in oil in living memory, and it would be foolish not to expect
some whiplash.
There is something vexing about Crude Volatility. The book explains that
oil prices left to themselves are inherently volatile, but that for most
of the history of the industry, producers have found ways to control
supply and stabilise prices. The portraits of the supply controllers are
etched with sympathy – McNally’s history strongly suggests that managed
markets were all but inevitable, and often preferable to the
alternative. He casts his account as a revisionist recuperation of the
monopolists and cartelisers. We need to ‘forget the monopoly man’
stereotype, he says, and realise that men like Rockefeller shouldn’t be
seen as tyrannical price-gougers, but as giants who helped everyone by
stabilising and lowering prices.
But McNally doesn’t muster his historical illustrations to call for a
new regime of market management, or to suggest that more planning might
not be such a bad thing. He establishes his case for the coming
volatility only to offer two words of vacuous advice: ‘Buckle up!’ We
have to get used to it. If you take McNally’s word for it, the crucial
policy implications of his analysis are the need to recognise the
drawbacks of variable import tariffs and to ‘resist the temptation to
crack down on speculators’, a group that presumably includes many of
McNally’s clients. Not only are they benign, he says, but by creating
opportunities for hedging, they provide an important buffer against
unforeseeable price swings.
Another puzzle of Crude Volatility is that McNally, whose claim to
expertise rests heavily on his experience in government, never discusses
his time in the White House, under a president (George W. Bush) and
during a period (January 2001 to June 2003) that must have been
exceptionally interesting for an oil hand. I had a hard time finding out
anything about it, except that Bush called him ‘Electric Bob’ and he
drew the attention of Congress and the press for meeting with Enron
representatives in the months before that company’s collapse. The book
itself has been bleached of any political residue, not only by its
author but presumably by the editors of the Columbia University Press
Center on Global Energy Policy Series in which it appears. They bemoan
the tendency toward ‘platitudes and polarisation’ and commit to make
their series an ‘independent and non-partisan platform’. This sounds
pleasant enough on the face of it, but has a ring of sociopathy when
applied to topics touching on the fate of the planet.
*
The silence about politics is eloquent of McNally’s personal politics,
which he has discussed more explicitly in more relaxed settings. ‘Most
of energy policy-making involves pragmatic, sensible adjustments to our
tax regulatory and security policies,’ he told an audience at the
Brookings Institution in 2004, just after he had left the Bush
administration (the sensible adjustments were done ‘by centrist
moderates of both parties’ – people rather like those at Brookings). As
long as prices at the pump stay low, he continued, most American voters
and politicians repose in ‘a state of deep, deep, deep sleep’, allowing
‘the folks who are really concerned about these problems to have
meetings like this and to work on solutions’. But when gas gets
expensive, ‘all of a sudden we flip onto mania and panic, and a search
for instant solutions.’ If oil prices can swing democratic polities
along with them, the question arises of what a new era of permanent
volatility might mean for politics. But in the speech, as in his book,
McNally has little to offer but hope that cooler heads will prevail,
along with confidence that most things (besides price levels) will stay
the same.
In a New York Times article from 2015 with the credulous headline
‘Experts Say That Battle on Keystone Pipeline Is over Politics, Not
Facts,’ McNally lamented to a reporter: ‘Why is what ought to be a
routine matter turned into an all-consuming Armageddon battle?’ As one
of his first acts in office, Donald Trump signed an executive order
reviving the Keystone project and the Dakota Access Pipeline, both of
which had been held up by the Obama administration after sustained
protests. The pipelines attracted opposition because of the immediate
risk posed by oil spills, but also because they touched on deeper
issues. Keystone XL is meant to connect US distribution centres with the
tar sands fields in Alberta. Extracting oil from tar sands is an example
of ‘unconventional’ oil production, the sort of method to which
producers turned only once supplies of ‘conventional’ liquid crude
became depleted. Unconventional drilling is ecologically more risky. It
also shows that the industry remains fixated on new discoveries, even as
scientists warn that proven reserves already represent more carbon than
we can afford to burn. The Dakota Access pipeline provoked similar
worries, but became an explosive issue because its proposed route
traversed land owned by the Standing Rock Sioux. In both cases,
opposition to the pipelines took the form of civil disobedience, serious
enough to force last-minute delays from the outgoing Obama
administration. The moment for cautious centrist adjustments to energy
policy, if it ever existed, has now given way to a new order in which
President Trump can command the Environmental Protection Agency to take
down pages from its website that discuss climate change. The protesters
at Keystone and in the Dakotas knew that when the stakes are this high,
there can be no separating facts, routine decisions and politics.
The dream of setting energy policy in a cork-lined room is even stranger
given the reality of climate catastrophe. Global warming is mentioned in
Crude Volatility only in passing. McNally is not a denialist, more of a
resigned agnostic: ‘Whether we like it or not, society’s continued
dependence on oil – at least in the near future – is basically ensured’;
‘blessing or curse’, we will depend on oil for ‘the foreseeable future’.
He offers a telling analogy: we know how to fix social security and
Medicare, he says (through ‘tax hikes and benefit cuts’, apparently);
but action on climate change is impossible because no politician can
succeed by asking voters to make sacrifices in the name of a better
future. The possibility that a different approach to entitlement reform
– funded by confiscatory taxes on the wealthy, say, which didn’t require
people on low incomes to submit to benefit cuts – might find greater
popular support goes unmentioned. Similarly, the possibilities for
addressing climate change without imposing insupportable burdens on
voters are ruled out a priori. It’s easy to agree with McNally that no
easy solution is in sight. But that is only the beginning of a thought,
not the end. How can it be that we can’t imagine changing something that
we know will destroy us?
In the years of constantly rising oil prices, before the bust in 2008,
the notion of ‘peak oil’ gained currency. Initially formulated by a
rogue Shell researcher, M. King Hubbert, in the 1950s, the idea was that
we had reached, or would soon reach, the high point of oil extraction,
after which production would fall off. Petro-optimists, including
McNally, have a ready answer to peak oilers. Fears of physical depletion
are as old as the oil industry, and have always proved to be unfounded.
High prices drive drillers to unlock previously unknown or inaccessible
reservoirs. The shale revolution – with its Promethean new technologies
such as fracking and horizontal drilling – was a textbook example, and
less has been heard about peak oil since prices fell and the US became,
for the first time in decades, a net exporter of oil. The moral of this
story is supposed to be that leftists, environmentalists and declinist
cranks always underestimate the near limitless potential of human
inventiveness to wring crude from the earth. But the attitude of
insiders like McNally to global warming suggests that they are the
fatalists, refusing to consider how we could avert the disaster everyone
knows is coming. In the face of the direst necessity, the champions of
ingenuity respond not with a strategy but a shrug.
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