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2014’s Biggest Economic Event

By Walter Donway

December 29, 2014

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“The U.S. will remain the world’s biggest oil producer this year after overtaking Saudi Arabia and Russia, as extraction of energy from shale rock spurs the nation’s economic recovery, Bank of America Corp. said.” – Bloomberg News, July 4, 2014

Without the coercive power of government (legal franchises, special privileges, favored treatment), no attempt at monopoly, or a business able to sustain its prices without regard for competition, can prevail in a free market. Its profits, above those prevailing in the market, will attract competitors, either producing its product or an alternative product, and they will gain market share by charging lower prices. The former monopoly will be forced to charge market prices or lose its customers. (The much-touted exceptions, beloved of anti-capitalist muckrakers like novelist Frank Norris, who wrote “The Octopus,” are monopolies that enjoyed government backing, the most infamous examples being the transcontinental railroads backed by huge land grants, special port-entry privileges, and other favors. These are “coercive” monopolies.)

It is a logically beautiful theory, and unassailable, but for more than a century, since enactment of the Sherman Antitrust Act in 1890, inspired by fear of what, in fact, were coercive monopolies (railroads) or temporary dominance by a company in an infant industry (Standard Oil), U.S. law enforcement of “anti-trust” legislation has grown in scope and power. Among its great victims have been Standard Oil of New Jersey, Aluminum Company of America, General Electric, Microsoft, and Apple. The list runs into thousands, indicted or intimidated, and reads like an honor roll of American capitalism.

How could this misguided, crippling, often bewilderingly arbitrary charade go on so long in defiance of logic?

How could this misguided, economically crippling, often bewilderingly arbitrary charade go on so long in defiance of logic? Because no demonstration in theory is proof against those who would exploit the complexities of economic life, as it actually exists, to challenge the theory—or, as in the case of antitrust law—excrete an ink cloud of confusion made possibly by the welter of multiple causes of any phenomenon in a modern economy.

Now, we can get specific. Today, every American, like most people in the world’s industrialized economies, is experiencing savings, in his pocketbook, at the gas pump, and when the oil-heating bill arrives. The chief cause represents a demonstration of the unsustainability of monopolies even in a semi-free, all-too-regulated, semi-capitalist system.

The demonstration takes the form of a plunge in the world price of a barrel of oil from more than $100 in September to about $55 as I write—a 40 percent price decline in one of the most important, pervasive commodities on the world market—literally, the engine of modern civilization. Headlines in the Wall Street Journal, the rest of the world’s financial press, but also in the New York Times and every other news source, have trumpeted this astonishing crash in the oil price.

So much is widely known. Also known, to any reader of the press, is that the plunge in oil price results, at least in large part, from competition. After all, the dominant supplier of the world’s oil for almost half a century has even had the name of a monopoly: the OPEC cartel. The Organization of Petroleum Exporting Countries was created 54 years ago by Arab nations led by Saudi Arabia (but including others, such as Venezuela and Nigeria) to fix the world price of oil (previously, each oil company had set the price of the oil it produced, but OPEC members expropriated this power from the companies).

The OPEC cartel, in 1973, flexed its monopoly muscle by denying oil to the United States and Europe, and then greatly hiking its price, sending those economies into deep recession, in retaliation for support by Western nations of Israel’s resistance to invading Arab armies. Back then, OPEC nations controlled two-thirds of the world oil markets. Oil drilling in Texas and Oklahoma, which once provided America with much of its petroleum, had peaked and was declining. OPEC called the shots and chose to do so as a cartel. It will be pointed out that OPEC is the quintessential coercive monopoly—a cartel of governments—and that is true.

What is impressive—no, inspiring—about this story is that even a worldwide semi-free market ultimately blasted away the monopoly price that the cartel sought to sustain. It was a challenge far greater than the market response to a monopoly not enjoying government backing.)

The economic response is a matter of record that I will not repeat, here. The semi-free economies certainly did respond to the OPEC monopoly price. Out of Germany, Japan, South Korea, and Detroit came the first generation of very small, energy-efficient cars, and they kept getting better and more fuel efficient; energy-saving and energy-efficient homes became a new trend; and, by 1986, a barrel of oil that sold for $35 in 1980 was selling for $10. This is one way a free or semi-free economy responds to prices: demand for the product is reduced by many, often ingenious, ways.

 

The “Supply” Response

But what about the supply of energy? Who was competing with OPEC to share its monopoly profits? In the years after WWII, with the dramatic and terrible demonstration of the power of atomic energy, a trend arose in the 1950’s toward the peaceful use of atomic energy and that trend kept growing until it seemed that every nation, every industry, and every power user—including especially the U.S Navy’s submarine fleet—committed its future to nuclear energy. The excitement was enormous, with predictions of virtually free energy. Installed nuclear energy rose from less than one gigawatt in 1960 to 100 GW in the late 1970s to 300 GW in the late 1980’s—an exponential growth of the kind that can revolutionize economies.

The industry surged ahead on a wave of scientific and technological optimism, carrying the banner “peaceful use of the atom,” but with too little attention to education of the American public who were their customers. And their neighbors, since nuclear power plants had to be constructed somewhere, in someone’s “backyard.” Seldom has the importance of the intellectual–the thinker, writer, editorialist, newscaster, or public advocate—in interpreting the world to the public been demonstrated more decisively than in the fate of the U.S. nuclear power industry. In this case, the demonstration decidedly was in the negative. What happens when intellectuals, for philosophical reasons, turn against science, technology, and economic progress per se? That is the story of the environmental movement as it became taken over by leaders who viewed man himself, his survival by productive use of his environment, as a blight on the “natural order.”

Irrational fears of nuclear power overwhelmed the record in reality of the nuclear power industry. But this could not have happened without the active involvement of the intellectuals whose job it was to bring reason and science to the public debate. Instead, they whipped up the fears of the public on every occasion, ignoring the actual record of the nuclear power industry and embellishing on the fantasies and fears of the public.

The rising environmental movement exploited to the utmost the fears and ignorance of the public.

This rising environmental/ecology movement exploited to the utmost the fears and ignorance of the public about the process that produces nuclear weapons—fears all too real in the Cold War nuclear confrontation between the Soviet Union and the free world—to attack the nuclear power industry. The indictment was not a “true bill.” The undifferentiated packaging of the horrors of nuclear explosions with the risks presented by nuclear power plants was dishonest. Responsible scientists continually pointed the misstatements, fallacies, and outright lies.

Of course, the nuclear power industry did not arise in response to the OPEC cartel; it preceded it. Scientific and technological advances driven forward by exigencies of war always have led to technological progress when peace arrives—at least in free markets ever alert to new sources of profit. But nuclear power became exactly the kind of “in waiting” technology that ambushes any attempt at monopoly; given monopoly prices, the latent—in this case, experimental—technology takes off. And the nuclear power industry both took off—and crashed—during the 1970s.

Nuclear power entered its commercial phase in the 1970s. Between around 1970 and 1990, more than 50 gigawatts (GW) of capacity was under construction, but the peak, at more than 150 GW, was in the late 70s and early 80s. Environmentalist attacks had dogged the industry almost from the start. But environmentalism, like nuclear power, was new. When it began to focus on litigation as a way to delay construction of nuclear power plants at every phase—delays that cost the industry hundreds of billions of dollars (e.g., in interest on financing and delay of income)—environmentalism won. The massive upfront expense of constructing safe nuclear power plants, the huge financing required, the litigation invited by ‘public responsiveness’ of federal regulatory agencies, the possibilities of litigation at several levels, at every stage, proved to be the giant killer.

But the nuclear power industry pushed ahead, doing much better in some locales (the South, the West) than in places (New York, New England, and California) where trends such as environmentalism were embraced by a liberal-left establishment and press. The blow that checked the momentum of the industry, and from which it never has recovered, was the accident in 1979 at Three Mile Island. Coverage by the media created a harrowing story, and, indeed, the accident was serious, with evacuations and disruptions of residents and lingering fears of contamination. A startling fact was evident immediately: There were no casualties. Not one. But the press highlighted the risk of longer-term effects of radiation; the population displaced by the accident returned home in terror of radiation exposure. We know, now, that every study and assessment of the effect on the population has revealed no increased health problems—after more than 30 years of intensive monitoring.

 

The Supply Response:  “Cancelled”

It didn’t matter. Nuclear power to generate energy in the United States, and to compete with the OPEC cartel (then already six years old), lost its momentum, and, to this day, has not recovered it. More than two-thirds of all nuclear plants ordered after January 1970 were eventually cancelled. In particular, though, a total of 63 nuclear units were canceled in the United States between 1975 and 1980—after Three Mile Harbor cancellation became an avalanche.

This was not the end of nuclear power. Nuclear power in the United States, today, produces 19 percent of our electricity. It is the most nuclear energy produced in the world by nation; but, not relative to population or total production, e.g., nuclear power produces 80 percent of electricity in France. And nuclear power plants proliferated, for example, in Japan, Israel, and few other nations without powerful environmental movements, more generally educated publics, and more informed about science.

But for our story, here, of how free markets can respond with new supply to prices that monopolies and cartels seek to impose, nuclear power became irrelevant. Plants already existing produce power (and in the United States, no notable accident has occurred since 1979; deaths caused by nuclear power plants in America remain at zero—making it widely recognized as the safest major source of power in our history). But the growth of nuclear power became irrelevant as a supply response to the OPEC cartel–and the trillions of dollars in national wealth transferred from America to Saudi Arabia and the other great Arab nations.

Nuclear power had been a sweeping, innovative response of the market to OPEC’s monopoly prices, a response playing to America’s strengths in science and technology. And it was a revolutionary response. Carbon-based fuels would be left behind: the coal-fired plants, the gasoline-powered internal combustion engines, the oil furnaces, the oil-powered utilities—all would be superseded by a potentially unlimited supply of nuclear power, producing almost none of pollution associated with carbon-based fuels. And if nuclear fission, the process that produced the atomic bomb, were supplanted by nuclear fusion, the source of power of the sun, then, yes—an era of unimaginable abundance of energy, at virtually no cost, would be upon us.

This is how capitalism–the freedom of innovators and producers to profit by creating new technologies, by making obsolete what once was indispensable, ushering us into the future–works. But reality, while it does not negate a true theory, may greatly complicate its impact.

 

The Monopoly Triumphant

For three long decades, from 1980 to 2010, the OPEC cartel dominated the world oil market. The great Sheikh families of Saudi Arabia played their hand craftily; their partnership with the U.S. government became exceedingly close. The U.S. Energy Information Administration estimated (as of 2009) that it costs Middle East producers less than $10 a barrel to “lift” their oil: maintain and operate the wells and related facilities and equipment; and less than $7.0 a barrel to find new resources–except that there often is little need for new resources. All the technology is Western as are all the great oil companies that keep the oil flowing. For the most part, that technology has become old-fashioned; but it has not mattered; drilling into the vast reserves beneath the desert is uncomplicated.

The Sheikh families of Saudi Arabia, by far the largest producer, extend into the hundreds and most are billionaires. Their yachts are seen in the all the swank harbors of Europe, especially Monte Carlo; their consumption of the services of the most elite French prostitutes is a matter of record. A massive transfer of wealth from the ‘consuming’ nations to the ‘producing’ nations has gone on for decades. With the emergence of India, the People’s Republic of China, South Korea, Vietnam, and other nations into the industrial, modern economy, the demand for oil has become fiercely competitive.

New oil supplies from the North Sea (“Brent”), Nigeria, Finland, and the Artic, including even the United States, provided some competitive supply of oil to check OPEC. And the canny Sheikhs of Saudi Arabia were aware that raising oil prices too high could push their Western customers into recession, lowering demand for oil. And this cozy relationship benefited the Sheikhs; no word from Western governments criticized the adamantly authoritarian, undemocratic, primitive rule of the Sheikhs. The murderous attack of September 11, 200l, an attack on civilization itself in the form of the World Trade Towers in downtown New York City–killing thousands of Americans and hundreds of nationals of other countries—was carried out by 19 Saudi Arabian nationals and planned and directed by a Saudi Arabian national, Osama bin Laden. The U.S. government responded with not one word of criticism of the Saudi Arabian Sheikhs, who promote a virulent fundamentalist version of Islamic religion.

In short, the OPEC cartel looked exactly like a government-protected monopoly, cozy with governments, resting on inside “understandings”—and draining trillions from U.S., European, and Asian economies in monopolistic profits that financed huge welfare states in the Arabian OPEC nations to pacify their populations—and leaving, in Saudi Arabia, two-thirds of the profits to the ruling families.

 

A semi-free, over-regulated market—but still a market

Given the theory of the destruction, by free markets, of any attempted monopoly pricing, it may seem discomfiting that it took more than three decades for the market to respond decisively to the OPEC cartel (and the story is far from over as we shall see).

The Sheikhs of the Middle East had staunch allies among the U.S. environmentalists and in the U.S. government. This has cost Americans, Europeans, and Asians many decades of paying monopoly prices for gasoline.

We have discussed how the supply challenge from nuclear power became permanently hobbled. In addition, as is well known, requiring little elaboration, here: Every initiative of the U.S. oil-drilling, refining, and shipping industries ran into opposition, regulatory delays, and political stonewalling by government. Whether it was opposition to offshore drilling, to drilling in the Alaskan wilderness, or building a pipeline to bring Canadian oil to U.S. refineries it ran into regulatory hurdles, litigation by environmentalists, or became a political football. The Sheikhs of the Middle East had staunch allies among the U.S. environmentalists and in the U.S. government. This has cost Americans, Europeans, and Asians many decades of paying monopoly prices for gasoline, heating oil, the firing of utilities, and the price of all transportation and almost all that they buy.

Despite all of it, and coming forward now to the present, U.S. and Canadian economies, and their innovators and entrepreneurs, against the opposition of regulators and sundry environmentalists, have asserted their classic role: disruption of settled, cozy markets—in bed with governments—to create earthquakes beneath the comfortable monopolies.

American industry already had exploited the readily accessible oil reserves of Texas and Oklahoma. Other oil resources—huge resources–lay beneath the ground in Texas, Oklahoma, the Dakotas, and much of western Canada—but were inaccessible to present technology or too expensive to drill. Thus, as the technology evolved in sites from the North Sea to the Gulf of Mexico to Venezuelan waters advanced—and as the OPEC oil prices reached $100 a barrel—a barrel that might cost $2 to produce—the North American oil drilling industry slowly, then not so slowly, came alive.

In truth, it never had died. It had kept drilling, experimenting, testing new methods, seeking fields more accessible. But then, perhaps 10 years ago, the oil price (and so potential profits), the technology, and the availability of capital (in the form, often, of less-than-investment-grade bonds or ‘junk”) came together to light a fire under the North American petroleum industry.

One technological key was horizontal drilling, which could follow the snaking flow of oil deposits between shale layers; another was ability to get at and use the heavy petroleum from the vast oil sands of Canada; and, as we all know, hydraulic fracturing, or “fracking”—the injection of fluids under super pressure to crack layers of shale to get the oil and natural gas flowing. In Texas, the Bakken of North Dakota, and the vast oil sands of Alberta the new oil pioneers were drilling, accessing the elusive, and increasing the efficiency of drilling. There was opposition at every step from environmentalists and regulators sympathetic to them. “Fracking,” an innovation that made the vast reserves of oil in layers of shale, was made a scare word by environmentalists.

But the North American entrepreneurs persisted, lured by monopoly prices sustained by the OPEC cartel, which made even difficult-to-access oil profitable. The impact on the market was long in coming, as the North American drillers grew, but what they had accomplished burst on the scene in September of this year. The price of oil in little more than four months plunged from $100 a barrel to $55 a barrel as of this writing.

In truth, several powerful factors came together to make the plunge in the price of oil so precipitous. One such cause was a sharp rise in the international exchange value of the U.S. dollar. For historic reasons, all oil worldwide is priced in dollars and the dollar has gained some 10 percent against the value of major world currencies. This automatically yields lower dollar prices for oil, but accounts for less than one third of the plunging oil price.

Another cause of plunging prices may be slackening demand—a favorite explanation in the financial press. After all, the world still is recovering from the once-in-a-century financial crisis of 2008, and the market crash and economic recession that ensued. The huge U.S. economy has been in recovery, with industrial production increasing, but European economies are still struggling and the long Chinese economic boom is cooling. The net impact on oil demand? Arguably demand is greater today than any year since 2008, given recovery of the American economy. Falling demand cannot explain very much of the recent crash in the oil price.

 

A July 4 Celebration

What is indisputable is that production of oil in North America in 2014, for the first time in decades, has caught up with Saudi Arabian production. Bloomberg News, on July 4, in a kind of unintentional celebration of American independence, wrote:

“U.S. production of crude oil, along with liquids separated from natural gas, surpassed all other countries this year with daily output exceeding 11 million barrels in the first quarter…The country became the world’s largest natural gas producer in 2010. The International Energy Agency said in June that the U.S. was the biggest producer of oil and natural gas liquids.”

It is a true revolution in production. OPEC has taken note, to put it mildly. Meeting in Vienna this month, OPEC members debated what to do about the crashing world oil price. The world’s media were there to watch every moment. World stock markets held their breath.

Many rulers of OPEC nations have kept their grip on power by means of distributing oil revenues; they pleaded for a decrease in OPEC production of oil, which would “stabilize” prices. The boss of the cartel, Saudi Arabia, staked out a more strategic position, worthy of a serious monopoly, ready to do battle for its position: keep oil production steady. (Saudi Arabia, almost alone among OPEC nations, has the financial reserves required to conduct a long price war to cripple their North American competitors while still funding their own welfare state.) Saudi Arabia is calculating that a plunging world oil price will destroy the new North American drillers, who require higher prices. Their technology is decades ahead of Saudi Arabia’s, but makes it more expensive to drill.

The world financial press is buzzing with speculation about the outcome of this price war. The new North American drillers, as start-up enterprises, and growing at top speed, are heavily in debt. Bloomberg News, in the same story, pointed out that “Annual investment in oil and gas in the country is at a record $200 billion, reaching 20 percent of the country’s total private fixed-structure spending for the first time.”

Can the North American drillers continue their operations, and remain solvent, at a world oil price that has plunged from by almost 50 percent? If the price remains suppressed below $60 a barrel, consumers will pay less for gas, heating oil, utilities, and anything that involves transportation, but can the North American oil producers survive?

It is a classic ‘price war’ in which the reigning monopoly, or cartel, drives down prices, taking temporary heavy losses, to destroy competitors. OPEC is acting like a classic monopoly. Doesn’t the classic view of monopolies imply that such tactics must fail? That the coercive monopoly, or cartel, cannot persist?

That is the theory in the context of a genuinely laissez faire economy, If the North American competitors operated in such an economy, they would not face (in the United States) the highest corporate tax rates in the developed world. They would not face costs of complying with regulation driven by environmentalists in and out of government. They would not face literally years of delay, by politicians such as President Barack Obama, politically beholden to environmentalists, in a crucial project such as the Keystone pipeline. In short, they would be fully free to compete.

To take just one example: How free are the North American oil companies to seek the profits they need to survive? Consider his final quotation from Bloomberg News: “A U.S. Commerce Department decision to allow the overseas shipment of processed ultra-light oil called condensate has fanned speculation the nation may ease its four-decade ban on most crude exports.” [Emphasis added]

The U.S. is heavily compromised by anti-scientific regulations and oppressive taxation.

One of the most dramatic demonstrations, in our day, of the theory that free competition makes coercive monopolies unsustainable, hangs in the balance. The theory is not in doubt, but the outcome of the demonstration is. Even one of the “freest” economies, the United States, is heavily compromised by anti-scientific regulations and oppressive taxation. And economies never operate independently of the level of understanding of their populations (look at nuclear power). And, finally, freedom depends upon the leadership of intellectuals whose sacred responsibility is to combat, not exploit, the ignorance and fears of the public.

 

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