Between June 2014 and January 14, 2015, crude oil prices
fell by 57 percent. Between November 1985 and March 1986, the prices had fallen
by 67 percent.[1]
That time, it took nearly two decades for oil prices to rebound. Would it take
that long again? The answer has implications for how efficient the market
mechanism itself is, and in turn for public policy on energy and global warming.
According to The Wall Street Journal, the discovery of oil
in shale rock makes all the difference. The difficult question involves what
that difference might be. With less time entailed from discovery to extraction,
and less cost relative to the more traditional sources such as off-shore oil,
the supply of oil on the market should be able to adjust downward much quicker,
resulting in higher crude prices, other things equal. For example, wildcatters
in Texas discovered the Eagle Ford Shale in 2008; within only five years, a
million barrels a day were going to market.[2]
“Faster-reacting shale production could help cut supply more quickly than in
the past, restoring market balance without a decadeslong wait.”[3]
This assumes the efficient market hypothesis—that suppliers quickly reduce
their respective contributions to the market as a result of lower prices.
So it is surprising that the Journal cautions that the
faster-reacting shale production does not necessarily “mean prices will rebound
soon, or return to the triple-digit levels . . . Price pressure may need to
remain on the U.S. oil industry and its lenders for months to rein in supply.”[4]
Andrew Hall, who runs a $3 billion energy derivatives hedge fund, wrote to
investors that it is unclear how long it would take for American suppliers to
cut back due to the lower prices and even what the new price-equilibrium would
be.[5]
For one thing, oil producers sunk into contracts would
rather get as much revenue as they can, even if they will still lose money.
Although shale producers have a shorter timeframe, the short life of a given
well means that the producers are under pressure to start new wells in order to
cover as much of the initial investment as possible. Put another way, keeping
production up is the better of two bad options.
With the tap expected to remain open, the supply of oil from
shale was predicted to peak in 2020, after which the annual decrease in oil
from liquid sources would be less and less made up by oil from shale. By 2030,
the production from liquid sources could be only half of its level in 2014,
with no oil left from shale. In short, the lack of a drastic downturn in supply
during the last half of 2014 suggests that the American economy might suffer
shocks in the 2020s as oil prices skyrocket from dramatically reduced supplies.
With alternative energy representing only about 3% of the total in 2014, even
increased investment in wind and solar facilities would not counter the
anticipated drop in oil supplies.
Had the oil market in 2014 been more in keeping with the
efficient market hypothesis—with supplies dropping drastically as the prices of
crude drop likewise until the reduced supply pushes the prices back, up at
least partially—the anticipated “cliff” in the early 2020s could be either
flatter or delayed. Policy makers would have more time to get the economic “up
to steam” on alternative sources of energy. Already in 2014, when I was driving
across the Midwest, I was stunned by the number (and size) of “wind fields.”
Even so, considering that carbon emissions were at the time going in the wrong
direction—up instead of down—the continued supply of oil in spite of the lower
prices must have been relieving pressure on policy makers to reduce the
reliance on fossil fuels. Meanwhile, the lower gas prices gave American
consumers the misperception that oil supplies are just fine and a lack of
incentive to obviate global warming above the 2C degree threshold.
In short, the lack of an efficient market was forestalling
vital public policies concerning both the American economy and climate change.
It is not that an efficient market would obviate government action. In fact,
just the opposite.
[1]
Russell Gold, “Back to the Future? Oil Replays 1980s,” The Wall Street Journal, January 14, 2015.
[2]
Ibid.
[3]
Ibid.
[4]
Ibid.
[5]
Ibid.
