Two energy economists discuss supply, collusion, jobs, and the impact on gasoline prices.
This week’s blog post is a podcast. Last Wednesday, I sat down (from a safe 2000 mile distance) with University of Chicago Professor (and Energy Institute alum) Ryan Kellogg to talk about how the sudden downturn in oil demand is affecting oil policy and politics in the US.
Here are some excerpts, but there is much more in the podcast.
Effect of the price crash on US production from existing wells and drilling of new wells
RYAN: “To profitably drill and frack a new well you need something in the neighborhood of $40 oil. So in terms of new drilling, what we’re going to see in the US is drilling of new wells basically go down to almost zero.” The effect on oil production will be primarily from the freeze in new wells, which will show up “later into spring and certainly in the summer.” But, “If prices stay at $20 and don’t go much lower, my guess is you’re not going to see a huge change in production from existing wells.”
How should US policy on the Strategic Petroleum Reserve (SPR) respond?
SEVERIN: When oil futures markets are in extreme contango, with two-year-out futures prices nearly twice as high as spot prices [Since we recorded, the difference narrowed. The two-year futures price was about 30% higher than spot at the close on Friday.], this price trajectory creates “some pretty strong economic arguments, regardless of the political motivation of supporting the price of oil, just for the government to make some money storing oil in the SPR.”
RYAN: “It’s an awful lot cheaper than putting oil in a tanker offshore, on rail cars, or all the other things folks are doing in the private market.
Should the US collude with OPEC and Russia?
We each found the fact that the federal government and Texas are seriously considering colluding to raise prices above competitive levels pretty shocking. And also bad for the US economy.
RYAN: “It looks like the market is actually being globally competitive, at least for the time being, which seems like something we should be celebrating rather than trying to push and cajole Saudi Arabia and Russia back into collusion, let alone collude with them.”
SEVERIN: “If our oil costs $40 a barrel and the Saudi oil costs $10 a barrel, and we managed to get oil back up to $50 a barrel, almost all of the rents are going to the Saudis, because while US oil producers would be able to profitably produce, they would be making rents of say $10 a barrel and the Saudis would be making far, far more.” “Our consumers would be paying much more for all of the oil, but most of the rents would not be going to US producers. They’d be going to producers elsewhere.”
Downstream price impact: A bigger drop in wholesale gasoline than diesel or heating oil
SEVERIN: “We’re also seeing gasoline prices drop in some ways even more drastically [than oil] at the wholesale level. It hasn’t come through to retail yet, but wholesale prices…are generally in the 35 to 50 cents a gallon range, which means that gasoline is actually selling for about the same or slightly cheaper than the oil that goes into producing it. It seems that part of what’s going on is the split between heating oil/diesel production and gasoline production because diesel hasn’t fallen nearly as much.”
Regional economic impacts, and jobs
RYAN: “People in the industry are being laid off…That’s an argument for doing the things we’re doing in the stimulus bill across the rest of the economy.” “These are not arguments for artificially inflating the price of oil which won’t do much to bring back jobs.”
SEVERIN: “It’s essentially bailing out mostly shareholders of oil companies…I’m sorry for everybody who’s losing money, but they shouldn’t be at the front of the line when we start thinking about who needs help through this crisis.”
To hear the full discussion (about 19 minutes), listen to the podcast
Ryan also posted an excellent related op-ed at Forbes.com on Friday.
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Suggested citation: Borenstein, Severin. “The Policy and Politics of the COVID-19 Oil Market Crash” Energy Institute Blog, UC Berkeley, April 6, 2020, https://energyathaas.wordpress.com/2020/04/06/the-policy-and-politics-of-the-covid-19-oil-market-crash/
Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. He chaired the California Energy Commission's Petroleum Market Advisory Committee from 2015 until its completion in 2017. Currently, he is a member of the Bay Area Air Quality Management District's Advisory Council and a member of the Board of Governors of the California Independent System Operator.