The sharp fall in oil prices threatens thousands of shale oil jobs, reportedly pushing an election-conscious White House toward considering federal assistance. Rather than fearing that a bailout will empower its shale-producing adversaries, OPEC+ should welcome one as a way of neutering the industry: a bailout will likely transform shale oil executives from dynamic entrepreneurs fixated on improving efficiency, to 21st-century robber barons who prefer to lobby congress for special favors.
In countries with powerful governments, there are two ways to make money: creating value or state-backed predation. The former is what we traditionally associate with the American dream: identifying a market niche, developing novel technology, and using entrepreneurial nous to expand. In competitive markets, if everyone plays by the rules, serving customers is the only way to make money, either by offering low prices or high quality. As the father of modern economics Adam Smith remarked: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”
This is how shale oil became successful during the last 15 years. Initially, a sustained period of high oil prices and cheap credit opened the door for high-cost shale oil producers. Then, the price collapse of 2014-2016 forced them to frantically improve their efficiency through technological advancement. This is why oil prices have declined by over 60 percent in eight years, but shale oil is still thriving, transforming the US into the world’s largest producer of oil.
Then there is state-backed predation, which can be as blatant as the privateers (government-backed pirates) that stole merchandise on transatlantic shipping routes in the early modern era, but also comes in the more subtle guise of the “swamp” in Washington DC. The idea is to let others create value and then manipulate the political system to seize the fruits of their labor in a legally permissible manner. Popular examples include securing government subsidies, protective tariffs, and legal privileges such as onerous health and safety regulations, all of which impede competitors.
Legal predation requires considerable effort and expertise, and the massive lobbying industry in the US and all western economies is a testament to the commercial sophistication of the process of manipulating the political system. Thus, when a company is deciding on its business strategy, there is a genuine tradeoff between allocating resources to innovation and technological advancements on the one hand, and to lobbying the government on the other hand. Learning to respond to the needs of customers is distinct from learning to respond to the needs of the politicians, and one comes at the expense of the other.
Thus far, owing to its limited contribution to the economy and employment, and to its nascence as an industry, shale oil has focused its efforts on creating value rather than predation. There have surely been some lobbying efforts, such as in securing approval to construct pipelines that go through territories owned by native Americans; but even there, the underlying goal is to deliver a better quality product at a lower price for its clients.
In fact, it is likely that the Russo-Saudi split on the continuation of OPEC+ reflects divergent assessments on the capacity of shale oil to continue to realize efficiency improvements. Some reports suggest that the Russians wish to check shale oil’s progress by forcing prices down for a sustained period, but skeptics respond that a similar expectation was held in 2015, only for shale oil to rise to the challenge of low prices by cutting costs ruthlessly. The industry is yet to consolidate, so significant managerial efficiencies remain available.
But all of that could change if the US government decides to bailout the shale oil industry in the wake of the current oil-price collapse. Once management learns to suck from the public teat, their entire mindset might change. Lobbying is a hard word, but it is less painful and has far better fringe benefits than engaging in cut-throat competition, as the latter inevitably entails morale-crushing layoffs and asphyxiating belt-tightening.
Therefore, from the OPEC+ perspective, it may well be better for the shale oil industry to surrender the traditional American dream, and to get stuck in the swamp of lobbying so that the next time prices fall, shale oil executives’ impulse is to call their congressmen rather than their engineers, and to slash the training budget in favor of corporate “sponsorship” rather than research and development. This could help keep the industry fragmented and unable to exploit economies of scale, placing a firm cap on the industry’s collective ambition and ability to threaten OPEC+. As German philosopher Friedrich Nietzsche once quipped: “If you gaze long enough into an abyss, the abyss will gaze back into you.”
Omar Al-Ubaydli (@omareconomics) is an economist at George Mason University.