Please Welcome Michael Pollak

I've read Doug Henwood's listserv lbo-talk for a long time. In fact, I blame it for this site. Seth Ackerman often posts stuff there, and it's always compelling—which is one reason why I've kept pestering him to write stuff here.

Lbo-talk also introduced me to another extremely interesting commenter, Michael Pollak. I've been after him too to chip in, and so now I'm very pleased to present the first of what hopefully will be many posts of his. As you'll see, it's in response to what Seth wrote yesterday. Both Seth and Michael are trying to answer the question: what is it the people who run America think they're DOING, for God's sake?

Be forewarned, however: Michael shares Seth's fatal flaw, which is knowing what you're talking about. This leaves both of them much less time for my specialty, which is crude insults and jeering.

by Michael Pollak

Seth,

I don't buy the Nitzan-Bichler theory, although I clearly haven't put as much work into the book as you have. But with that qualification, I think this Kinsley anecdote is kind of perfectly timed to highlight the central problems with the Nitzan-Bichler theory.

When it comes to this oil prices, I'm a conventional thinker. I think oil companies do like price stability for all obvious reasons that have always been given. The only time they like war is when it's very short -- like Gulf War I, which has clearly just finished when Kinsley is having this conversation. At that point, oil prices had been suffering from glut since the mid-1980s (the third oil shock, the one that everyone forgets, the negative oil shock, the one that had Poppa Bush running to Saudi Arabia to get them to raise prices). And then, during GWI, just for a few months, the price spiked enormously. And then went back to its previous level. It was one of the shortest, most successful wars in history. And it was one of the steepest and shortest price spikes in history.

Well, you can see why an oil man would want to have one of those again. It was an idyllic example of the fabled windfall profit. Oil companies did nothing and money just fell in their lap.

But what you don't want as an oil company is a war that keeps oil prices high for an extended period of time. Because then you run into three problems that are all very much increasingly in evidence now -- and which have always invariably recurred since oil first became an industry in the 1860s whenever disturbances have kept prices high for an extended period:

1) Resource nationalism

Oil price contracts are between countries and country-size companies. There is no higher court. It's a purely a matter of power. Whoever has more power gets more money.

When oil prices are low, oil companies have more power. Countries are starved for income and dying for investment. They can be forced to make deals that are outrageously in the companies' interests. And so long as the oil price stays steady (or even better, goes up slowly and steadily) the oil companies keep the whip hand. The countries can't afford the losses that would be incurred by abrogating those agreements.

But double the oil prices and suddenly the producing countries are rolling in money. And then they have the whip hand. And all the advantageous contracts that were agreed to in time of scarcity are "renegotiated" -- i.e., torn up. And the oil companies have to take it. Because they do have contracts at the consumer end that they have to honor or they'll get sued.

As you rightly say, its all about percentages. Gas companies in Bolivia were a lot happier paying 18% of a low price than 82% of a high one.

2) Consumer nationalism

Oil companies are the juiciest scapegoat in the world. No one trusts them and no one likes them. And when price jump dramatically and stay up, the people cry for their heads. The longer they stay up, the more the cry for windfall profits taxes and removing incentives and renegotiating contracts -- whatever will take it out their hides.

The current US government is the exception that proves the rule. This has to be the most oil friendly administration and congress in history. And even here you can see how congressmen feel they have to at least pretend to hit the oil companies. In the past, they did hit them. It takes sole ownership of the government to make it not happen now. And once the oil companies are hit -- in consumer countries, this means an increase in taxes and decrease in subsidies and, most importantly, changes in the bookkeeping and restrictions on doing business -- that hit stays until the balance of power shifts the other way. Which in a consumer set-up happens when prices are stable for a long time. Because that's when gas prices recede into the background. And then they can write in their depletion allowances and lease terms and everybody's eyes glaze over. In consumerland, stable prices are the grail for goldilocks reasons: oil prices going down is always bad; and going up too fast means unwelcome attention; but going up slowly is just right.

3) Huge, long-term fixed investments

This of course is the main reason that oil companies like stability -- and the main reason they hate wars that keep prices high for years at a time and uncertainty of any kind.

If you're going to sink a couple billion dollars into an infrastructure project that's going to last for 30 years, you've got to have an estimate of how much oil is going to cost. And so long as prices are being artificially inflated by war, you don't know what that price is. So no one is going to build a project based on $60 a barrel oil. But if they don't, and prices stay that high, then they'll slowly get squeezed. Producers will take a larger and larger cut. And if it goes on long enough, they'll start nationalizing billion dollar infrastructure projects you've already built. This is the oil companies' idea of hell. This is when their power is at a minimum vs. the other two players in the game.

But so long as the faux inflation lasts there's nothing they can do. If no oil investments are made based on an oil price above $30, and the market price stays $60, supplies will get steadily tighter and their power position will get rapidly weaker. But if they make a long term investment in oil that wouldn't normally be profitable -- let's say at $40 a barrel -- and then, 5 years from now, oil comes back down to $30, then they're fucked. They'll have to keep pumping the oil because of the financing and the contracts with the country. But if they dump it at a loss, the market will go into a death spiral. This is *exactly* what happened after the second oil shock in 1979, which was purely a matter of disturbance in the middle east -- there was no real underlying shortage, just leapfrog buying as distributors and consumers tried to secure supplies. And when all the investment made at that level came on line in mid-decade, oil prices cratered for the next decade and more.

Oil companies would have no trouble investing based on $40 a barrel or $50 a barrel so long as they're sure that's the underlying price based on supply and demand. But that's just it: you can't be sure that's true when prices are artificially inflated. And you doubly can't be sure when they've jumped suddenly and then plateaued at double their normal level. Because then you have a second problem. Not only do you not know what the true long term price is, but there is a 100% margin for using new technologies that have never been used before -- the results of which are by definition incalculable. It might turn out that with that much incentive someone really will come up with a way to make oil shale into a marketable product at $45 a barrel. And that when that opens up whole new huge reserves we'll be back in the land of glut. In which case every multi-billion dollar project based on $50 oil would be a ticket to bankruptcy.

And oil companies do go bankrupt -- all the time. (Although a lot of the time it's called mergers.) Despite their unfathomable amounts of power and money, oil investing is still a hugely risky business. And the reason it will always stay risky is because so much money is at stake, and because the time lines are so long. Keynes defined radical uncertainty as trying to guess the price of commodity in 20 years. Anyone want to bet 3 billion dollars on it? Without even worrying about being nationalized or renegotiated against your will? Or the problems inherent in running through extreme geographical and political environments -- which is the case with almost every new investment from here on out?

So that's why oil companies like stability: it maximizes their power and it maximizes their return over the long term. And the guys who really run the oil companies -- not the drones who fly retail who were ironically joking with Kinsley -- always think in the long term. It's the nature of their business.

One last footnote: the one thing the oil companies have most wanted in the middle east for the last 20 years -- and the thing they still most want in the middle east -- is the ability to invest in Saudi Arabia again on ownership terms. And in the mid 90s they were closer than they'd ever been before. It's conceivable that if they'd had just 5 more years of collapsed oil prices, they probably could have pulled it off -- they were this close to getting the gas contracts that would have led to the oil. Saudi Arabia was famously strapped and suffering badly for it. And now, poof, that's all gone for the foreseeable future. This was not the middle east future the majors wanted.

IMHO, of course.