In the Game of Barrels, Adapt or Die

By: Contributor - Jan 8, 2015, 12:41 pm

By Guillermo Luis Covernton


The dramatic changes to global petroleum prices have begun to attract the permanent attention of the media in recent months. The current value of a barrel of crude is barely half of what it was only a few months ago.

Every week sees various articles analyzing the causes and consequences, deploying the opinions of experts of every stripe. But it’s interesting to see how the different economic doctrines of the last 80 or 100 years are now reflected, to varying degrees, by public opinion.

A diferencia de la crisis de la década de 1970, los precios del petróleo no caen por decisión de la OPEC.
Unlike the crisis of the 1970s, current global petrol prices aren’t falling due a decision by OPEC. (Flickr)

In a recent article by Moisés Naím published in the Spanish version of El País, the author makes several reflections, some hypothesis and other simply opinion, which will likely be revealed within months to have been rather extreme and lacking in any foundation.

He argues forcefully that just as petroleum crisis of the 1970s provoked highly significant geopolitical changes, the situation of current prices could be equally influential.

As professional economists we have the obligation to enlighten public opinion, and, on occasion, to contradict it.

The first difference that should be pointed out between now and then is that the fall in petrol prices during the 1970s was due to a planned drop in production, as the cartel of exporters speculated with their product. OPEC tried to abuse its dominant position over the market, coordinating activity to the detriment of consumers.

By contrast, the current drop in value of the same commodity seems to be, quite simply, due to the costs of oil extraction becoming cheaper. A great number of investment projects, most of them privately-owned, have matured, and made use of the application of new production technologies.

The discovery of technologies which permit the exploitation of hydrocarbons (in gas or oil form) located in shale rocks beneath the earth’s surface has proved to be hugely significant. It’s allowed producers to exploit huge reserves which previously were inaccessible due to prohibitive costs. These were formerly kept back as a strategic reserves for extreme cases such as armed conflicts.

Seizing Opportunities

Is it correct to say that some countries will end up winning from this, while others will be losers? For example, that the biggest consumers and smallest producers will receive a windfall, while the big producers and exporters will lose out, as their consumption is marginal compared to their volume of production? Or, to the contrary, are the benefits likely to reach everyone?

There’s a strong temptation to argue that we’re dealing with a veritable conspiracy by several developed nations and economies (The United States, Great Britain, the Netherlands, Norway) to get one over on countries like Venezuela, Iran, Russia, and the Arab states.

If some end up winning and others wind up losing, we could say that the fracking phenomenon is neutral: it will be praised or condemned according to whoever’s speaking. If it brings progress and well-being for everyone, however, we could argue that it represents a victory for human progress.

The most elemental economic theory tells us that fracking is definitely beneficial for the entire planet. And when I refer to the “entire” planet, I’m referring to any citizen of the world who confronts his or her problems with economic rationality and with respect for their peers. That’s to say, “for every person of goodwill.”

The possibility of now disposing of greater quantities of petroleum at ever smaller cost is the product of technological advancement. One form of capital known as scientific or technical knowledge has handed us something that didn’t exist before.  This is every bit as positive as the increases in agricultural yields secured by agronomic advances and adaptation of each species of crop to the relevant ecosystem.

We’re definitely all much wealthier as a result: now we know how to do things that we couldn’t before. We need less money and fewer resources to secure the same quantity of energy we needed before.

Won’t there be winners and losers? Good economic thinking should teach us that humankind’s main problem is the distribution of resources. Not the scarcity of resources — which many who pass for experts have often, and wrongly, tried to tell us.

For economists, scarcity isn’t the problem. In any case, an engineer who manages to obtain the same chemical compound by extracting it from an abundant, low cost resource, does much more to lessen scarcity than an economist. And if through some new discovery or chemical synthesis we could obtain petroleum in greater quantities than we currently need, it could end eventually up being a “free good.” We could end up seeing petrol as readily and freely available as drinking water in some parts of the world.

Instead, the issue is one of distribution: determining how much of a certain input, and how much capital, should go towards each method of production. It’s a matter of deciding whether to favor capital intensive and high productivity systems, or less productive industries which require lesser quantities of often scarce resources.

Winners and Losers

The fall in petrol prices will doubtless result in certain investments being redirected: this is the magic of liberal capitalism. Investors and businesses win or lose as and when their informed guesswork hits or goes wide of the mark.

If we want to establish whether the winners will create losers, or if everyone will win, it’s key to understand that free market economics isn’t a zero-sum game. Alternative products and systems are discovered, which are later adopted or imitated, or which in the worst case scenario force us to switch to other activities and deploy our resources in a different way.

Put another way: for everyone who lives in a republican system, with respect for private property and democracy, with respect for dissent, minorities, and individual rights, it’s good news.

Technological progress, the development of advanced, high-tech production systems, highlights global institutional disparities: those countries which have strong institutions will monopolize the investment and technology. By contrast, those nations whose impoverished institutional development makes them ineligible to receive these new technologies, have two possibilities: they can change, or let their chance at progress slip away.

The evolution of the global petroleum market is good news for all those prepared to take advantage of it. They’re already becoming more prosperous every day as a result. Although, on the way, some might have to modify their business plans, so much the better. This will only improve the distribution of scarce economic goods.

Guillermo Luis Covernton is Professor of Macroeconomy, Microeconomy and Public Finances at Argentina’s Universidad Católica, and Academic Director of Fundación Bases.

Translated by Laurie Blair.