Oil Production Quotas

Member Group : Lincoln Institute

Oil prices have virtually collapsed and OPEC and other oil producing nations are considering quotas and production limits to drive prices up.
The damage to the oil producing nations of lower oil prices is clear but the benefits of a free market system operating freely is even more significant. Impeding the free operation of the free market system is the greatest risk of the low oil prices, free markets, and any economic recovery.

Once governments interfere in markets, disaster inevitably results.

A disaster is a virtual guarantee to any market interfered with because of the irrefutable laws of supply and demand, the concept of enterprise risk, and governmental attempts at picking winners and losers in an otherwise free market.

The laws of supply and demand are natural laws not subject to any government. They are laws caused by people interacting with one another due to their mutual self-interests. Producers will supply more goods and services at higher prices. Consumers will purchase more goods and services at lower prices. When the prices of consumers are willing to pay coincide with prices producers are willing to offer, a market price emerges and transactions take place.

Some may not like the decisions that one makes with their free will but to interfere with that free will has untold unintended and unforeseeable negative consequences.

When markets become distorted either through the nature of the market (such as a monopoly or an oligopoly) or due to government intervention, resources no longer are allocated as the consumer wishes resulting in both short term and long term market dislocations.

Every effort to manipulate markets by government has failed.

During the 1970’s the government, the Council on Wage and Price Stability was established to bring prices and wages under control due to the problems of the Vietnam War and "excess" demand relative to supply which was believed to have caused wild inflation.

In an article called "The Legacy of the Council on Wage and Price Stability" the authors conclude that "the authors detect persistent deficiencies in the economic analysis regulators often use to justify new regulation".

This same conclusion can be applied to virtually every government effort to interfere with markets except where there are market competitive fairness questions such as has been addressed by the Sherman and Clayton Antitrust Acts.

Short of preventing anti-competitive market influences which are in effect nongovernmental attempts to distort markets, governmental efforts at controlling markets always fail. The Russian wheat embargo imposed by President Carter backfired on Iowa wheat farmers, minimum wage legislation has backfired on younger workers, the Affordable Care Act has been anything but affordable, and quantitative easing has backfired on savers and retirees.

In reality government efforts at interfering in markets has usually done more harm than good and the same will result if government(s) interfere with oil quotas. The solution may feel good in the short run but will be disastrous in the long run.

Allowing markets to operate freely allows for market participants to decide winners and losers. In the case of oil, consumers benefit from lower prices at the pump and producers are encouraged to slow down new drilling because economic circumstances changed.

The damage from establishing oil quotas to increase prices will come from the following:

1. Producers will realize that the markets in which they operate are contrived thereby increasing enterprise risk of even being in the industry

2. Lenders to oil producers will find bank loans to drillers more susceptible to loss due to market manipulation thereby either reducing funds available or increasing fees hurting future exploration.

3. Equity markets will find capital riskier thereby driving up the cost of equity in the long run

4. Consumers will be encouraged to shift demand to lower cost of fuel which on the surface may appear attractive in the short run but in the long run will shift energy demand to alternative fuels which are then subsidized because of "cross elasticity" of demand.

5. Any good or service when subsidized gets the market "more" of the good or service but if the actual demand is not there without the subsidy, failure of the next market is inevitable. The housing market being subsidized with "no doc" loans is a prime example

To resolve market problems government’s role should exclusively be to protect the competitiveness of the market and not to pick winners and losers.

Col. Frank Ryan, CPA, USMCR (Ret) and served in Iraq and briefly in Afghanistan and specializes in corporate restructuring and lectures on ethics for the state CPA societies. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at [email protected] and twitter at @fryan1951.