President Joe Biden needs to read more.
First, he should read a biography of Theodore Roosevelt. Roosevelt practiced quiet diplomacy while carrying a big stick for last-minute persuasion. Biden should also glance at Principles of Economics by Harvard professor N. Gregory Mankiw. The professor explains that economic cartels such as OPEC are rarely successful in achieving their goal of raising prices through an agreement to reduce production. Members of the cartel cheat.
OPEC HUMILIATES BIDEN ONCE AGAIN
Such reading is relevant because of OPEC’s agreement on Wednesday to reduce by 2 million barrels a day oil output quotas among its members. However, OPEC is a loose oligopoly with more than 20 members. Only two of those members truly count. Those being Saudi Arabia and the United Arab Emirates, the UAE. Only those two countries in OPEC have significant excess capacity and are politically stable. Russia, which is not part of OPEC, participates as part of OPEC+ deliberations. That said, Russia always cheats by maintaining production at higher levels than those agreed. Importantly, Saudi Arabia and the UAE are economic and political rivals. Diplomatic relations between the two countries are fragile.
Given the rivalry, the temptation to cheat is high. As Mankiw explains in his textbook, in an economic cartel, “the largest gains will go to the party who cheats first on any agreement so any agreements are very fragile.”
Put simply, this new agreement is hot air. Historically, OPEC agreements always fail. Saudi Arabia is typically the last to cheat, it becomes the swing producer. Saudi Arabia loses revenues. The Saudis know oil and the history of oil production agreements. They will talk cuts but nothing more. In a few weeks, the political hysteria will evaporate, and oil prices will reflect supply-demand fundamentals.
Don’t believe me?
Take a U.S. country study by Helen Metz. Writing about Saudi oil policy in the 1980s, Metz observed that “Saudi Arabia’s adherence to an official price system … rendered the kingdom the swing producer. Saudi Arabia was forced to curtail output to ever lower levels. Other members ‘cheated’ on their quotas. In 1979-80, Saudi Arabia had peaked at a production of more than 10 million bpd; by 1986, that amount had reached a low point of 3 million bpd.”
The Biden administration knows that the latest agreement is much ado about nothing. So why is the administration raising the political temperature in the Middle East and driving Saudi Arabia closer to Russia and, for that matter, to China as well?
It is all about the midterm elections. The Biden administration wants to discourage the production and consumption of oil in the United States, but the administration also wants low gasoline prices. Consequently, the administration encourages overseas oil production to keep supply up and domestic gasoline prices down but discourages domestic production to satisfy “green” zealots. All the world’s a stage, and we Americans are merely being played for idiots.
But it’s worse than that. After all, by making an ephemeral production cut a big deal, the Biden administration has increased oil market uncertainty. Markets hate uncertainty. Biden’s short fuse is causing oil and gasoline prices to move higher. He shouts but the Saudis don’t listen. And Biden has no obvious stick.
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James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
