Just Say 'No' to Government Oil

 | Jan 13, 2012 | 4:30 PM EST
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Context is important. In the case of oil, context is very important.

Unfortunately, some politicians have been taking oil out of context and seem to be describing incredible plans to nationalize domestic oil. They appear to be unaware of context or consequences.

The average American believes the U.S. is importing significant amounts of oil from the Middle East. As a result, many believe the U.S. is overly dependent on the Middle East and some are demanding we "Drill, baby, drill!" off our coasts and in our parks to secure "our oil."

First, we import far less oil from the Middle East than many realize. Second, the oil industry currently depends on a free market that is responsive to supply and demand to determine price.

Yes, some producing nations, such as the Organization of the Petroleum Exporting Countries, attempt to manipulate supply in the hopes of controlling price. And there are financial derivatives, developed by free-market institutions, that have the unintended consequence of inflating demand (see Dan Dicker's Oil's Endless Bid: Taming the Unreliable Price of Oil to Secure Our Economy). In the end, however, the free market is what provides price discovery and liquidity. It also makes crude oil financially fungible.

Based on market prices, and considering costs and risks, exploration and production (E&P) companies such as Chevron (CVX), ConocoPhillips (COP), Exxon Mobil (xom), Apache (APA), Anadarko (APC) and Hess (HES) search the world for the low-hanging fruit. The easiest pickings are basins where oil production can easily be developed and transported at the lowest possible cost. As producers achieve larger spreads between costs and market prices, they can achieve higher profits for shareholders.

Free-market principles are important to allow the industry work efficiently. Those who advocate changing national energy priorities and direct E&P companies to drill more domestic oil are really advocating the abandonment of free-market principles.

Sure, open up some restricted fields for drilling. Virginia and other states would welcome offshore drilling and tax anything that comes close to its shores. But if free markets are maintained, don't be surprised if E&P companies take their time before arriving off Virginia's shores; there could be lower-hanging fruit waiting elsewhere.

To take the political position that we, as a nation, must harvest "our oil" as a matter of federal policy requires substantial changes within the oil industry and government. Given what has been offered, those changes could include the federal government forcing E&P companies to abandon the free market, drilling domestically at a rate needed by central planners and against their financial interests.

By chanting mindless slogans like "Drill, baby, drill!" and empty phrases like "our oil" without offering detailed explanations, politicians are sending a message that they want to suspend the free market and introduce policies that take a mercantilist approach toward domestic oil.

Current political messages are even more confusing. Several presidential candidates (I won't say who to avoid getting into partisan sniping) said that they were thinking out of the box, wanting to increase domestic drilling and flood the market with oil and gas, lower the price of oil and make consumers happy. Owners could then heat their homes affordably and life would become serene. (Nothing was said about keeping oil and gas producers happy.)

There is a problem with this. We don't need more natural gas. More importantly, if these politicians believes in free markets and plan to use them, they would realize that his plan would immediately fail.

In order to flood domestic markets as they describe (because oil is financially fungible), they would first have to flood the international market. Of course, more crude in the world means countries like China and India would also see higher supplies and lower prices and would likely start substituting costly fuels for lower cost oil, and that would ultimately increase worldwide demand. If supply and demand economics work, in the end, high prices would return and America will find itself pumping oil like crazy.

Maybe these politicians had something else in mind.

Maybe they wanted to limit the benefits of increased drilling to "our nation." This approach would require the government to step in and assure "our oil" is only consumed by "our citizens."

To make sure the plan works, only flood the domestic markets with domestic oil and force national prices to drop. "Our oil" would have to be withdrawn from international markets. This would require suspending the free market and introducing more government.

And why not say that if elected president, they would open up as many regions for exploration as is practical?

I say let individual states make their own decisions and let the free market work. Why force non-market solutions if you don't have to?

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