As if virus mania weren’t enough: oil prices have crashed, down at least 25% percent in a mere 48 hours, after falling more since last week. Yes, that’s the largest price drop since 1991. No, it is not the end times. This has almost nothing to do with virus fears. It’s the result of a much-overdue price war among producers from which the consuming public will benefit. Amid the waves of bad economic news, this is actually good news.
Here’s the background.
The weekend news that Saudi Arabia was poised to begin both slashing
prices and ramping up production following the failure to come to an
OPEC agreement sent world oil markets plunging on Sunday afternoon and
evening. West Texas Intermediate futures fell 24.59 percent ($10.15) to
$31.13/barrel, and the global Brent international price fell 21.3
percent ($9.65) to $35.58 – in both cases, the worst percentage drops
since the air phase of the Gulf War began in January 1991.
Saudi Arabia has the lowest production price in the world. It
produces between 9.7 and 9.8 million barrels per day, but it may ramp
production up to between 12 and 13 million barrels per day. (Saudi
Arabia’s production price per barrel, the rough equivalent of “overhead”
in managerial accounting, is estimated at $10 per barrel; Russia’s is
estimated at $19 per barrel.)
Oil stocks fell similarly, with drilling companies announcing that
they would suspend exploration activity and producers reducing capital
budgeting: as benchmarks, the Energy Select Sector SPDR Fund fell 20
percent, while the Oil and Gas Exploration and Production Fund fell 35
percent. Alongside the precipitous drop in oil-related commodity and
equities prices, prices of worldwide equity indices continued their
coronavirus-induced plunge from last week, and US Treasury bond yields
fell across the board, with the 30-year falling below 1 percent and the
10-year falling below 0.5 percent for the first time.
But many market watchers and participants seem to be caught up in the
hysteria. A price war between Saudi Arabia and Russia should (beyond
oil-industry interests) be a welcome development, beset as consumers
presently are with the impact of government tariffs, travel
restrictions, anti-“gouging” measures, and other factors which retard
the flow of much-needed goods, services, and people. Economic policies
during such a time should favor the immediate, dramatic reduction of hurdles to trade.
Beyond the most obvious benefit to consumers in the form of lower
gasoline and motor oil prices – crude oil prices make up more than 70
percent of the price of gasoline per gallon – oil is obviously a major
factor in industrial production. Critical products made from it number
in the thousands and include jet fuel, kerosene, diesel, heating oil,
waxes, plastics, asphalt, dyes, grease, solvents, inks, and innumerable
others.
Lower prices for both final consumer goods and in the prices of
production goods are beneficial for a wide variety of productive
applications. Government subsidies distort and politicize attempts to
incentivize alternate-energy research, creating opportunities for
corruption and rent-seeking; lower oil prices entice a wide variety of
market participants to explore not only alternative energy solutions,
but also cheaper production processes in their existing, core lines of
business.
To be sure, this will prompt a reorganization of the industry. It
could signal a pause in shale-oil drilling (which will make many
ideological leftists happy, however temporarily). Investments in oil
production will be less profitable for now. If you understand something
about supply and demand, you will also recognize what this means for oil
consumption. Those hoping for the near end of internal combustion will
be sorely disappointed.
The beauty of what we are watching now is that it again proves what many of us already know: markets work. If we let them.
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