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March 16, 2020

Don’t Bail Out the Oil Industry (or the Banks)

Economic justice and capitalist principles agree.

We need relief for the people who are laid off or can’t work because the schools are closed and their children need care. We don’t need and shouldn’t have relief for large businesses or banks; been there and done that in that last recession.

I have lots of friends in the oil and gas industry. I wish them no ill and even believe that their constructive use of fracking and horizontal drilling has made America stronger and richer. In the course of this bust and boom cycle (and many before it), large fortunes have been made. Doesn’t bother me a bit when the fortunes go to those who took risks or were innovative. One of the risks they took in exchange for their wealth, however, was that one day a bell would ring and the next bust cycle would be upon them.

Ding. The bell rang when the coronavirus shock was too much for the unholy Saudi-Russian alliance. Down came oil prices.

Economic justice

 Intolerable income equality comes from creating a ratchet where wealth can be gained but never lost. The rich have more to lose and lose more when assets lose value. Bailing out the banks and others in 2008 was a huge mistake both because it left assets over-priced and in incompetent hands and because it took the risk out of risk/reward. Economic justice requires that the people can both get rich and unrich.

Wealth which just keeps growing becomes so powerful that it tends to monopolize future wealth creation. It dominates both the political and the economic sphere. Recessions are “nature’s” way of making sure fortunes don’t grow to the sky. Bailouts interfere with that natural cycle. They are a constant threat because the rich have political power.

If oil prices are allowed to continue crashing (as they will for a while absent a bailout), consumers will benefit. This is the same as a tax cut except that it doesn’t compete for government money and it is progressive in the sense that the rich spend very little of their income on heat and transportation. Cheap oil is a great stimulus.

Cold hard capitalism

Let’s assume we DON’T bail out the oil companies. Many will stop drilling whether we bail them out or not. Some of them will go bankrupt. That’s what Putin thinks he wants so that they’ll stop taking Russia’s marketshare and he can raise prices again. But he’s wrong.

Let’s say oil has crashed to $20/barrel. Could easily happen. The price of oil won’t be enough to both pay the loans that financed the drilling and pay the incremental costs of production. Many drilling rigs will end up lying down; wells will be capped or never completed.  So far, so good for Putin. But then what?

When the oil companies go bankrupt, their assets don’t disappear. The banks (who shouldn’t be bailed out either) will have to sell these assets for any price they can get. Eventually someone with some money and lots of nerve will buy them for a song. The assets are in the hands of innovators. Now there are no loans to be paid off; just workers to be paid and wells that were near completion. Now land with drilling rights is available for a song. So, when Putin and the Saudi’s try to raise prices because their populations are restive, the capped wells with no great debt burden get uncapped; the debt-free rigs get raised; and American oil is back supplying not only America but most of the rest of the world. Whoops.

If we bail out the oil industry so it can keep charging higher prices and survive, if we bail out the banks which lent to them, if save them both from bankruptcy, we let Russia and Saudi Arabia charge more for longer. We delay the day when we’re back in the game. Meanwhile our consumers and manufacturers pay higher prices than if there were no bailout.

The above isn’t economic theory; it all happened four years ago when Saudi Arabia tried to crush American frackers and drove prices from $100/barrel to under $30. One year later oil was back up to $45 and Americans were back taking market share from Saudi Arabia and Russia. Once the debt was relieved and innovation let loose, we could compete at the new lower price.

Bubbles and busts are part of the cycle of economic growth. Bubbles make capital come flooding into finance assets until there are more assets than demand for the product the assets produce. Bankruptcy lowers the cost of the asset and the product produced by the assets enabling future growth in demand.

In the 19th century there were railroad bubbles. Too many railroads got built. Fortunes were made… and then lost as many of the railroads went bankrupt because there wasn’t enough freight to pay the debt. But, after bankruptcy, there were lower freight prices. Crops could get to market economically. Freight increased. Cue the next cycle.

Same thing happened with the Internet bubble. It attracted too much capital; there was a bust; assets were priced down. Cheap always-on Internet service became available. Good times were here again.

And in conclusion

It would be an economic injustice to bail out the oi companies and the banks which financed them; another bailout will (and should) bring the tea party and the socialists out in force. A bailout would also be economic folly; it’ll help block the road to America’s recovery. Meanwhile, low gas and heating oil prices are just what the doctor would’ve ordered if she weren’t so busy treating the virus.

See also:

Why we need bubbles

We’ve Been T*RPed

Election Analysis: It Was TARP that Boiled the Tea

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