OPEC, Credible Threats, and the Noble Sacrifice of American Oil

By December 10, 2015Blog

At the start of President Obama’s second term, the American Oil Industry was untouchable. Prices were stable, employment was skyrocketing, and new technologies promised an ever-increasing supply for years to come. Sure there were some setbacks; just like everyone else, the industry took a hit during the Great Recession. Unlike the broader economy, however, it was relatively quick in its recovery. According the Bureau of Labor Statistics, it took a little over two years for oil and gas related jobs to return to pre-Recession levels, as opposed to almost six for the nation as a whole. At its height, the U.S. shale oil boom even seemed like it could accomplish the impossible: making North Dakota a desirable place to live.

But alas, it was not to last. The start of 2015 saw America’s oil train come to a shrieking halt as OPEC finally responded to the meteoric resurgence of North American oil production. Led by Saudi Arabia, the summer of 2014 saw the cartel of oil producing countries abandon its long-standing policy of cutting production to stabilize prices, seeking instead to maintain market share by pricing their competition out of the market.

The effect of this policy change has been swift and chilling. Crude prices have plummeted over 60% from their 2014 highs, clocking in at just under $37 per barrel for the first time in recent history. The relatively high-cost shale oil industry has been predictably hard hit. Domestic production, which nearly doubled between 2010 and 2014, remained stable in 2015 and is expected to decline by one million barrels per day over the next 12 months. Employment likewise shrank nearly 8% from the December 2014 high of over 201,000 jobs.

To many Americans, this decline must seem both tragedy and travesty. The death of well-paying American jobs at the hands of foreign competition is one (and probably the only) shared lament of both Bernie Sanders and Donald Trump. Instead of mourning the loss of these jobs, though, we should be praising them. Why? Because they’ve bought us cheap oil for years to come.

In Game Theory, the field of economics that studies strategic interactions, there is a concept known as the “credible threat.” It’s pretty much exactly what it sounds like, stating that if one player tries to better themselves at the expense of the other, the first player can expect the second to retaliate because it is rational and beneficial for them to do so. This concept is the academic underpinning for the doctrine of mutual assured destruction. To put it another way, it’s the reason the world hasn’t been consumed by the beautiful disaster of nuclear Armageddon—at least if you’re a cynic. (For the less morbid of you, there’s always mutually assured humiliation. Thanks John Oliver!)

By proving the viability of domestic oil production when prices are high, the American oil industry has established our credible threat against the supply-restricting policies of OPEC. The message of this threat is clear: keep the oil flowing and prices low, or American producers will gobble up your market share. It’s unlikely prices will remain quite as low as they currently are; resuming discontinued shale operations will inevitably incur startup costs, meaning OPEC will have some wiggle room in the short term. At the same time, though, improvements in technology and operational efficiency have and will continue to reduce the per-barrel cost of shale oil production. As long as this threat of North American competition continues to loom, sustained prices of over $100 a barrel are a thing of the past.

So while the shale oil bust is a significant blow to domestic oil workers and investors alike, it brings with it a significant boon to the broader U.S. and global economies. For better or for worse, we are still an oil driven economy and cheaper gas means greater efficiency and more money to spend on other goods and services. This reality can change, of course, and quickly too. The COP21 summit certainly provides an interesting backdrop to the oil wars. The push for a carbon-neutral, renewables-based economy is strong and getting stronger, and it’s entirely possible the coming decades will see the nuances of oil production become irrelevant. In the meantime, though, when you’re filling up with that sweet, sweet sub-$2 gas, whisper a quiet thank you to American oil workers. They’ve certainly earned it.

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