However, such models assume that all market participants are seeking to profit-maximize over relevant time horizons. This is simply not an accurate depiction of the global crude market. Many players with substantial market share are classified more accurately as political institutions rather than private enterprises. The former’s energy strategy ultimately caters to not just rational economic decision-making, but to political objectives as well. Morris Adelman, the late and renowned oil economist, posited that political institutions’ behaviour in crude markets systemically differs from the notion of what, in the sphere of economics, would be considered a ‘rational’ firm.
Jurisdictions dependent upon the production of oil and gas rely heavily on revenues generated from their exportation. The result for many of these ‘petro-states’ is undiversified national revenues and assets. Furthermore, sovereign states are not beholden to higher authorities and have responsibilities beyond those of private enterprise (geopolitical risk, etc.). Thus, petro-states have both the incentive and power to hike crude prices.
These factors together culminate in petro-states persistently choosing shorter time horizons than a private company would for their investment decisions. Instead of taking the long view, governments end up highly valuing short-term gains to satisfy their current fiscal needs rather than maximizing returns over the long term.
This trait is common among all OPEC producers and it can be seen as a major catalyst for quickly generating collusive outcomes. Recently, the effectiveness of said catalyst has decreased as North American producers have developed ways to be better poised to respond against OPEC induced price volatility.
The effort to reduce costs across shale plays in the United States has been substantial. The most influential aspect of the effort has been the large number of developed uncompleted wells (DUCs). These are rigs that are only partially drilled to save costs and create reserves. The collection of these wells has been collectively referred to as the Fracklog and can be ‘online’ within 4-5 months. This time horizon falls well within the time it takes for state cartels to coordinate elevated price levels.
Where crude prices are today, private companies and petro-states would both enjoy a price increase. For a government, an argument can be made that a price jump is more desirable, since they maintain a relatively shorter decision-making time horizon, and would take action quicker than private enterprise. Break even prices for balanced OPEC budget’s lie beyond $70 per barrel. This is a price level that also constitutes healthy expansion opportunities for US shale players. In fact, upstream producer Pioneer Natural Resources recently stated that $50 crude was all that was needed to restart production on certain plays the company holds in the Eagle Ford formation.
Indeed, claims that U.S firms are now collectively swing-producers fail to make much sense under the most common definitions of oligopoly; the situation where a few big players can agree to restrict production to raise prices and share monopoly profits. However, when one considers the structural differences between firms and states, the term’s application becomes more tenable. Though several OPEC nations have the a very low cost structure to produce their crude, the costs of running a government make their effective to-market costs much higher.
Traditionally, responsibilities of a government generate short-term ‘crisis’ thinking. This thinking catalyzes collusive action to increase price levels. This norm however is gradually being challenged by firms (read US unconventional players) adapting to price pressure with innovative ways of increasing their price responsiveness, taking profits away from OPEC and reducing their incentive to collude. As sovereign states seek to balance their budgets, they simultaneously are demanding a price level at which unconventional US reserves are once again competitive, making them behave like high cost producers.
Since price volatility is generally accepted as a byproduct of OPEC collusion, more so than unexpected supply disruptions, crude markets therefore might not experience another high price level for sometime. Thus, the price of crude oil going forward will undoubtedly be more stable.