Lower Gas Prices Would Be Bad, Actually

The cool bite of autumn on the prowl drifted through the open door at a sunlit café I’ve found in Braga—my new city-of-choice here in Portugal. On an amble around our new neighborhood, my wife and I spent a spell dispensing with two meia de leite, a Portuguese version of a latte, at a small table near crystalline windows looking out over the pine-shrouded mountains beyond.

At a small end-table nearby, I’d found a picayune collection of tattered paperbacks, and I picked up one to while away the minutes whilst awaiting the arrival of our coffees and the pastel de natas we ordered. Portugal has given the world a lot—cork, port, Vasco de Gama—but for my money the sweetened, egg custard tart tops them all.

As for the book… it was Catch-22, a novel I last picked up in 10th or 11th grade as part of an English-class lesson on satire. Honestly, I don’t remember a lot about the book, though I do recall Captain Black, the military intelligence officer who thought he was intelligent because he was an intelligence officer… and who surmised that, even though he served in a non-combat position, he should serve as the new combat squadron leader because the title “intelligence office” proved he was the most intelligent. (Note: He was an idiot.)

I didn’t know it at the time, but Captain Black personifies the Dunning-Kruger Effect—a cognitive bias in which a person believes that they’re smarter and more capable than they really are. Said another way: Incompetent people do not possess the skills needed to recognize their own incompetence.

Anyway, the coffee was good, the pastel de nata was fantastic, and my wife and I love our new life in Braga.

On to other news…

We’ll start with this story from CNBC last week:

Shale oil executives say President Donald Trump is hurting investment in the oil patch, and are giving a grim outlook for the future of the industry that turned the U.S. into the largest crude producer in the world.

The executives’ anonymous comments were published in a quarterly survey of oil and gas companies by the Federal Reserve Bank of Dallas this week. The 139 companies that responded operate predominantly in Texas as well as northern Louisiana and southern New Mexico…

Trump’s push for lower crude prices, higher tariffs, and the resulting uncertainty caused by his “stroke of pen” policies are hurting investment, executives at independent oil and gas producers told the Dallas Fed.

Nearly 80% of executives who participated in the survey said they have delayed investment decisions in response to heightened uncertainty about the future price of oil and the cost of producing crude.

“We have begun the twilight of shale,” one executive said, pointing to layoffs by the thousands and industry consolidation under big companies like Exxon Mobil.

“The writing is on the wall,” the unnamed manager said.

Another executive warned that “drilling is going to disappear” as Trump pushes for $40 per barrel crude oil at the same time his steel tariffs are raising costs. U.S. crude oil prices are currently trading around $65 per barrel, just above the level producers need to drill profitably.

Oil is an ugly business.

I covered the industry for several years as a writer in The Wall Street Journal’s Dallas bureau. This was back in the late ’90s, when oil prices had crashed from about $40 per barrel to less than $15… on their way to about $12.

Throughout the Permian Basin out in West Texas and across Louisiana’s oily Gulf Coast, drilling rigs sat idle, towns saw unemployment spike, oil businesses went bankrupt, local businesses shuttered.

But from those debilitating lows of the late ’90s, oil prices shot the moon over the next 10 years, peaking near $125 before collapsing again.

It’s just the ebb and flow of oil: High prices always lead to low prices, low prices always lead to the industry’s partial collapse, and then low prices always lead to even higher prices later.

Right now, we’re in the midst of what looks to be the industry’s next, periodic partial collapse.

Oil prices have lost 50% in the last few years. More than 27,000 jobs have been lost so far. And the administration’s rallying cry, “Drill, baby, drill,” is the equivalent of Captain Black insisting he’s intelligent because he’s an intelligence officer.

See, the thing about drilling, baby, drilling is that drilling leads to finding more oil.

And finding more oil increases the supply.

And increasing the supply leads to lower prices because there’s not enough demand to sop up said supply.

And lower prices mean thinner profits for energy producers… or no profits at all, if oil prices fall far enough.

And thin/no profits mean exploration and production companies don’t go around poking holes in the ground looking for new oil because that’s a multimillion-dollar expense for which they don’t have the cash… because oil prices are too low and their profits are too thin to absorb the cost.

And when the E&P guys, as they’re known, don’t poke new holes in the ground, then the production side of the business doesn’t have new oil reserves to tap into as existing wells run dry.

And when no new reserves are coming online just as demand catches up with supply that depletes every single minute of every single day, then the industry finds itself in the midst of a supply shock—not enough new supply to meet new demand…

And oil prices that have collapsed suddenly reverse course and roar higher. Often higher than before.

Oil today is $65 per barrel, right at the price the US energy industry needs to profitably drill new wells.

Anything below that price and the industry starts to shutter its exploratory activities.

But Captain Black wants oil prices much lower, down to $40 so that gasoline prices come down. It’s an intelligence officer’s take on what he assumes will make him the beloved commander of the squadron: give the people what they think they want right now, while disregarding the impact on the industry that will cause problems for the people later.

Alas, oil at $40 would be a disaster.

Pump prices would certainly crumble to levels that would have a certain segment of society crowing about how smart Captain Black is because he’s saving them so much money on filling up the Escalades and Suburbans they need to ferry around a laptop and a Teacup Shih Tzu.

Then the knock-on effects materialize in the form of oil industry bankruptcies and vast numbers of lost jobs in drilling, production, and all the ancillary sectors that service drilling and production.

Those knock-on effects: Oil prices that race well past $100 per barrel again, and gasoline prices that surge well past $5 per gallon again.

And it means even higher electricity prices because a great deal of US electricity is a function of natural gas combustion, and roughly 40% of America’s natural gas production is a byproduct of oil production… and if E&P companies aren’t searching for new oil because the math of drilling doesn’t math, then natural gas production declines as well, even as demand for natural gas is racing higher these days, which pushes up nat-gas prices… which then flows through electricity prices.

I guess the point is that the Dunning-Kruger Effect doesn’t just afflict unintelligent intelligence officers, it also runs deep in those pushing state capitalism on the American economy.

More soon on the destructive nature of state capitalism…