- Crude Volatility: The History and the Future of Boom-Bust Oil Prices by Robert McNally
Columbia, 300 pp, £27.95, January 2017, ISBN 978 0 231 17814 3
When Donald Trump nominated Rex Tillerson, the CEO of Exxon, as secretary of state, Robert McNally found the choice unremarkable. ‘The closest thing we have to a secretary of state outside government is the CEO of Exxon,’ he said. McNally is an energy consultant, a former adviser to George W. Bush, Mitt Romney and Marco Rubio, and a member of the National Petroleum Council.
Crude Volatility would be a good title for a biography of Trump, but McNally’s book was written before the election and studiously avoids political controversy. The book expands on a pair of articles (written with Michael Levi) in Foreign Affairs, which argued that recent fluctuations in the price of oil marked the end of a period of relative stability that began in the late 1970s. The first piece ran in 2011, when the yearly average price of Brent crude exceeded $100 for the first time. The follow up, ‘Vindicating Volatility’, came in late 2014, after three years of relatively stable prices had given way to a new price collapse. The book, which appeared in January when prices were around $55 a barrel, gives a deeper historical exposition of McNally’s (so far valid) forecast of persistent price volatility.
Since drillers in Pennsylvania first struck ‘rock oil’ in 1859, the uses of petroleum have shifted – illumination, electricity, heating, machine lubrication, fuel for internal combustion engines – but through it all, market forces by themselves have been unable to bring supply and demand into balance at a stable price level. This is unusual. If a blight makes tomatoes, say, harder to come by, tomatoes will be more expensive and consumers will demand fewer of them and buy other kinds of produce instead. If farmers overestimate the popularity of tomatoes they will grow too many and the price will fall, leading some farmers to stop supplying tomatoes and start growing something else. Either way, the market for tomatoes will find an equilibrium, a price level at which no producer willing to accept the going rate will be left with unsold produce and no buyer willing to pay the going rate will find empty shelves.
In the case of oil, however, both demand and supply are unusually unresponsive (inelastic) to changes in price. Oil is too important and difficult to replace for a rise in price to cause a fall in consumption. And if prices fall, the relatively low cost of continuing to run existing wells (as opposed to the stupendously high costs of bringing new oilfields on line) means that supply won’t immediately fall far enough to bring prices back up. But both supply and demand can have long-term consequences: oversupply may continue because of the completion of drilling projects begun in times of scarcity, or demand may begin to lag after a boom because consumers have gradually responded to high prices with ways of permanently replacing oil – as happened in the US in the 1970s, when oil was replaced as a source of electricity by natural gas, coal and nuclear power. This instability is frustrating for producers, who by themselves are powerless to control supply in response to price fluctuations. But if many sellers co-ordinate their actions (either because of voluntary collusion or imposed constraints) they do have the power to administer stable prices where the market cannot.
The bulk of McNally’s book tells the history of the oil business as a series of such attempts to control supply. These efforts, he argues, have been successful enough to make us forget that stable oil prices are unnatural and can’t be counted on. They can be maintained only through painstaking and ultimately unsustainable co-ordination between businesses and governments. In 1931, as global depression took hold and prices fell, the governor of Oklahoma shut down oil wells by military force, declaring that ‘the price of oil must go to $1 a barrel; now don’t ask me any more damned questions.’ Price stability grows from the barrel of a gun, not the ministrations of the invisible hand. But precisely because the project is so political, it is also fragile. McNally argues that we have become used to price co-ordination over the past century, but that era is now at an end. No single actor – not even the king of Saudi Arabia – is today powerful enough to exert the kind of control once enforced by the Oklahoma governor.
Oil – the compacted remains of prehistoric life – has always oozed to ground level, and people have always found something to do with it: caulking their canoes, painting their faces, lubricating their tools. In the 1860s, whale oil became too expensive to use as a source of light, and start-up hucksters in Pennsylvania discovered they could pump oil out of the ground in greater volumes than anyone expected. As the market grew rapidly, the industry developed a tendency towards overproduction. With a growing economy, demand would surge and prices would go up, leading wildcat drillers to flood into the oil regions; oversupply would lead to price collapses and ruin the men who had sunk everything they had into pressurised wells and pumps. In the thick of this entrepreneurial swamp, John D. Rockefeller recognised that in a free market, voluntary co-operation would always give way to ruinous competition. Assiduously, Rockefeller and his Standard Oil trust integrated the chaotic functions of the oil business, and struck deals with the railroad companies that brought oil from the fields to market. In doing so, they did great violence to the ideal of free competition, but also rationalised the industry so that it could supply fuel at stable prices.
McNally, following such business historians as Ron Chernow, argues that Rockefeller’s market power led not only to stable prices but to consumer-friendly bargains. The public wasn’t so charitable at the time, however, and anti-monopoly resentment meant the break-up of Standard Oil and the transition to a period of competitive volatility. This interregnum came to an end in the 1930s, when the stakeholders in Oklahoma and Texas – Pennsylvania’s successors as the centre of American oil production – established legally enforced production quotas limiting production under the aegis of the Texas Railroad Commission. New oilfield discoveries in the Middle East were integrated into the Texas regime of price control when the dominant companies, known as the Seven Sisters, signed favourable concession deals with the emergent postcolonial states.
The Texas cartel reached the highpoint of its control over global oil production in the 1950s. But triumph quickly led to overreach when the world-bestriding conglomerates tried to impose a punitive price reduction on Middle Eastern and Venezuelan oil. Iran, Iraq, Kuwait, Saudi Arabia and Venezuela formed Opec – a global cartel of oil producing nations self-consciously modelled on the Texas Railroad Commission (even employing former TRC consultants on retainer). They began to experiment with production agreements and export quotas. When the United States set itself at odds with Arab nations in the 1973 Yom Kippur War, Opec responded with an embargo that marked the end of the Texas era of oil stability and introduced a new system of supply control on an even greater scale.
In the context of the broader economic dislocations following 1973, Opec’s assertion of power seemed definitive. But commodity anti-imperialism was a paper tiger. In the long run, Opec couldn’t force people to sell at high prices, or stop new oilfields being discovered in parts of the world that weren’t subject to their agreements. The key to controlling world oil prices, McNally insists, was spare capacity: control over existing oilfields that could be brought on line when demand rose and shuttered when demand fell. At one point, Rockefeller’s Standard Oil had occupied this role; in the Opec era, Saudi Arabia did its best. But the role of swing producer exacts serious costs. You have to be willing to buy dear and sell cheap, because the whole system depends on your countervailing pricing. Ultimately, the vagaries of demand and the constant discovery of new oilfields meant that no single country was willing or able to be the swing supplier. And so, according to McNally, the long exception of stable, administered oil prices has come to an end. Opec, so unsettling to Americans in the 1970s, is now powerless to control the dramatic fluctuations – from $147.27 on 11 July 2008 to $30.28 on 23 December 2008 – characteristic of the new oil market. We have come to inhabit, McNally concludes, the first free market in oil in living memory, and it would be foolish not to expect some whiplash.
There is something vexing about Crude Volatility. The book explains that oil prices left to themselves are inherently volatile, but that for most of the history of the industry, producers have found ways to control supply and stabilise prices. The portraits of the supply controllers are etched with sympathy – McNally’s history strongly suggests that managed markets were all but inevitable, and often preferable to the alternative. He casts his account as a revisionist recuperation of the monopolists and cartelisers. We need to ‘forget the monopoly man’ stereotype, he says, and realise that men like Rockefeller shouldn’t be seen as tyrannical price-gougers, but as giants who helped everyone by stabilising and lowering prices.
But McNally doesn’t muster his historical illustrations to call for a new regime of market management, or to suggest that more planning might not be such a bad thing. He establishes his case for the coming volatility only to offer two words of vacuous advice: ‘Buckle up!’ We have to get used to it. If you take McNally’s word for it, the crucial policy implications of his analysis are the need to recognise the drawbacks of variable import tariffs and to ‘resist the temptation to crack down on speculators’, a group that presumably includes many of McNally’s clients. Not only are they benign, he says, but by creating opportunities for hedging, they provide an important buffer against unforeseeable price swings.
Another puzzle of Crude Volatility is that McNally, whose claim to expertise rests heavily on his experience in government, never discusses his time in the White House, under a president (George W. Bush) and during a period (January 2001 to June 2003) that must have been exceptionally interesting for an oil hand. I had a hard time finding out anything about it, except that Bush called him ‘Electric Bob’ and he drew the attention of Congress and the press for meeting with Enron representatives in the months before that company’s collapse. The book itself has been bleached of any political residue, not only by its author but presumably by the editors of the Columbia University Press Center on Global Energy Policy Series in which it appears. They bemoan the tendency toward ‘platitudes and polarisation’ and commit to make their series an ‘independent and non-partisan platform’. This sounds pleasant enough on the face of it, but has a ring of sociopathy when applied to topics touching on the fate of the planet.
The silence about politics is eloquent of McNally’s personal politics, which he has discussed more explicitly in more relaxed settings. ‘Most of energy policy-making involves pragmatic, sensible adjustments to our tax regulatory and security policies,’ he told an audience at the Brookings Institution in 2004, just after he had left the Bush administration (the sensible adjustments were done ‘by centrist moderates of both parties’ – people rather like those at Brookings). As long as prices at the pump stay low, he continued, most American voters and politicians repose in ‘a state of deep, deep, deep sleep’, allowing ‘the folks who are really concerned about these problems to have meetings like this and to work on solutions’. But when gas gets expensive, ‘all of a sudden we flip onto mania and panic, and a search for instant solutions.’ If oil prices can swing democratic polities along with them, the question arises of what a new era of permanent volatility might mean for politics. But in the speech, as in his book, McNally has little to offer but hope that cooler heads will prevail, along with confidence that most things (besides price levels) will stay the same.
In a New York Times article from 2015 with the credulous headline ‘Experts Say That Battle on Keystone Pipeline Is over Politics, Not Facts,’ McNally lamented to a reporter: ‘Why is what ought to be a routine matter turned into an all-consuming Armageddon battle?’ As one of his first acts in office, Donald Trump signed an executive order reviving the Keystone project and the Dakota Access Pipeline, both of which had been held up by the Obama administration after sustained protests. The pipelines attracted opposition because of the immediate risk posed by oil spills, but also because they touched on deeper issues. Keystone XL is meant to connect US distribution centres with the tar sands fields in Alberta. Extracting oil from tar sands is an example of ‘unconventional’ oil production, the sort of method to which producers turned only once supplies of ‘conventional’ liquid crude became depleted. Unconventional drilling is ecologically more risky. It also shows that the industry remains fixated on new discoveries, even as scientists warn that proven reserves already represent more carbon than we can afford to burn. The Dakota Access pipeline provoked similar worries, but became an explosive issue because its proposed route traversed land owned by the Standing Rock Sioux. In both cases, opposition to the pipelines took the form of civil disobedience, serious enough to force last-minute delays from the outgoing Obama administration. The moment for cautious centrist adjustments to energy policy, if it ever existed, has now given way to a new order in which President Trump can command the Environmental Protection Agency to take down pages from its website that discuss climate change. The protesters at Keystone and in the Dakotas knew that when the stakes are this high, there can be no separating facts, routine decisions and politics.
The dream of setting energy policy in a cork-lined room is even stranger given the reality of climate catastrophe. Global warming is mentioned in Crude Volatility only in passing. McNally is not a denialist, more of a resigned agnostic: ‘Whether we like it or not, society’s continued dependence on oil – at least in the near future – is basically ensured’; ‘blessing or curse’, we will depend on oil for ‘the foreseeable future’. He offers a telling analogy: we know how to fix social security and Medicare, he says (through ‘tax hikes and benefit cuts’, apparently); but action on climate change is impossible because no politician can succeed by asking voters to make sacrifices in the name of a better future. The possibility that a different approach to entitlement reform – funded by confiscatory taxes on the wealthy, say, which didn’t require people on low incomes to submit to benefit cuts – might find greater popular support goes unmentioned. Similarly, the possibilities for addressing climate change without imposing insupportable burdens on voters are ruled out a priori. It’s easy to agree with McNally that no easy solution is in sight. But that is only the beginning of a thought, not the end. How can it be that we can’t imagine changing something that we know will destroy us?
In the years of constantly rising oil prices, before the bust in 2008, the notion of ‘peak oil’ gained currency. Initially formulated by a rogue Shell researcher, M. King Hubbert, in the 1950s, the idea was that we had reached, or would soon reach, the high point of oil extraction, after which production would fall off. Petro-optimists, including McNally, have a ready answer to peak oilers. Fears of physical depletion are as old as the oil industry, and have always proved to be unfounded. High prices drive drillers to unlock previously unknown or inaccessible reservoirs. The shale revolution – with its Promethean new technologies such as fracking and horizontal drilling – was a textbook example, and less has been heard about peak oil since prices fell and the US became, for the first time in decades, a net exporter of oil. The moral of this story is supposed to be that leftists, environmentalists and declinist cranks always underestimate the near limitless potential of human inventiveness to wring crude from the earth. But the attitude of insiders like McNally to global warming suggests that they are the fatalists, refusing to consider how we could avert the disaster everyone knows is coming. In the face of the direst necessity, the champions of ingenuity respond not with a strategy but a shrug.