Buckle Up!

Tim Barker

  • 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 full text of this book review is only available to subscribers of the London Review of Books.

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