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The broken world economy can’t seem to provide enough of the things we want or need — personal protective equipment, coronavirus testing kits, a night out, toilet paper — but it is able to produce lots of things that nobody wants to buy right now, especially petroleum.
The astonishing move in the crude oil futures market CLM20, +15.29% on Monday and Tuesday signals more than disruption in a thinly traded financial product; it shows the folly of subsidizing something that, for a brief glorious moment, is actually marked-to-market as being more trouble than it’s worth.
The coronavirus pandemic has exposed a lot of faults in our economy. We’re seeing which parts of the economy truly are essential and which parts are parasites.
Breaking news: President Trump backs aid for oil and gas companies
If you believe in the magic of free markets, what’s happening in the oil industry must be shocking. Demand for oil is dropping like a stone everywhere, but most producers are still pumping almost as much as they were before, so much in fact that we are running out of places to store it.
That’s why the May crude oil futures contract CLK20, -9.49% went through Alice’s rabbit hole on Monday and arrived in a looking-glass world in which speculators had to pay others to take oil off their hands. If you didn’t already have a place to store it, being forced to take physical possession of all those barrels of surplus crude oil would be ruinous.
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Petroleum has become a game of hot potato. No one wants to hold it when the music stops.
And yet it’s still gushing out of the ground.
Profits don’t matter
Why wouldn’t oil producers react to the drop in demand by reducing their pumping and drilling? Because most producers don’t care about maximizing their profit; they have other goals, such as maintaining or increasing market share, or maximizing short-term revenue, or holding on to the political power they’ve accrued. They don’t mind selling at a loss.
Everyone sees the need to produce less oil, but only if someone else takes the hit. The cartel tries to make a deal to reduce supply, but the deal can’t possibly be sustained because everybody knows that everybody else will cheat.
Government subsidies lubricate this system. President Donald Trump is offering to take lots of crude oil off the hands of domestic producers. He offered to buy 75 million barrels to fill up the existing Strategic Petroleum Reserve, even though that oil will most likely never be burned. Congress scuttled that idea, at least for now.
There are plans cooking within the administration for even more audacious ideas, such as paying producers to leave oil in the ground and pretend that it’s part of the SPR, ready to be released to the market in case of an emergency. The government will never take possession of that oil, of course.
The curse of petroleum
All these subsidies are designed to help America achieve “energy independence” but it seems more like a prison to me.
In fact, our economy is just as dependent upon oil as it was in the 1970s and 1980s, just in a different way. High prices used to kill the economy, but now it’s the other way around. The stock market used to rally when oil prices fell because lower prices were a windfall to consumers and other users. But now the market drops when oil does.
Our economy has become addicted to the growth created by investment in oil drilling and production.
It’s an age-old story: Nations blessed with natural resources seem cursed, while nations that must rely only on their wits seem to do better. Their economies are stronger, and so are their democracies. Crony capitalism thrives in oil-rich nations, like America.
For a brief moment, we can see the reality of petroleum. Maybe we’ll remember when this is over that oil is more trouble than it’s worth in more ways than one. The global economy still needs cheap petroleum, but not for long.
We know that petroleum and other fossil fuels are hastening another, even more dangerous crisis, and we must act very soon if we don’t want to bequeath a hotter, more hostile planet to our grandchildren.
