The Triumph of the Consumer in the Falling Oil Prices

The news that oil prices are going down for quite some time is being reported as a gamble by the Saudis, who are supposed to have had a heavy influence on OPEC’s decision not to stop production. As Ambrose Evans-Pritchard writes in the Telegraph, “Saudis risk playing with fire in shale-price showdown as crude crashes.”

gas tax

Saudi Arabia and the core OPEC states are taking an immense political gamble by letting crude oil prices crash to $66 a barrel, if their aim is to shake out the weakest shale producers in the US. A deep slump in prices might equally heighten geostrategic turmoil across the broader Middle East and boomerang against the Gulf’s petro-sheikhdoms before it inflicts a knock-out blow on US rivals.

Basically, from what I can tell reading Evans-Pritchard, many countries have managed to survive what are basically socialist or fascist economies by using oil as a source of income for the government. So now crashing oil prices are presenting those governments with a terrible crisis.

But what I find interesting, based on this and other things I have heard on the radio, is how OPEC really had no other choice.

The only way that OPEC can get high profits is by limiting production in order to drive out the price. This allows them to hope to get more profit for each barrel of oil they sell.

But the “problem” is that these higher prices have stimulated investments in natural gas production in the United States and elsewhere. This extra supply of fuel is lowering the price of energy.

So what can OPEC do about this? They have two choices. First, they could cut production and raise energy prices and increase the profit per barrel of oil. That is an attractive option to countries run by governments that basically feed off of oil profits. But if they do that, then U.S. natural gas will also become more profitable. This means that the industry will attract more investment and production will increase. As a result, the OPEC nations will lose market share and, over time, lose their ability to sell oil profitably.

[See also, “Airlines & Fuel Prices: How Our Media Leads Us Wrong.”]

The second option is to allow production to continue. What that would mean is that the price of oil will sink even further. This will mean that oil production will be less profitable but U.S. natural gas will also be less profitable. Since natural gas is more expensive to produce, we can expect to see the U.S. natural gas industry slow a bit. Investment will be directed elsewhere.

But it will always be there waiting for the moment when prices go up. Basically, OPEC is stuck. They can hope to cause a decline in the natural gas industry, but then they will only be able to raise prices at some point for a short period of time. Because as soon as prices get high again, the natural gas industry will be re-energized as the higher prices attract more investment.

The real lesson here is that the free market benefits consumers. In fact, one might say it benefits the consumers at the expense of “old money”—those who have inherited a fixed resource and who don’t attempt to get wealth through new innovations and inventions.

The world simply doesn’t work the way liberals want you to believe that it does. Freedom drives prices down.