More domestic production won't lower gas prices

The argument for increasing oil production in the U.S. to decrease gas prices at the pump has sparked passionate debate, but it undervalues the influence of the Organization of Petroleum Exporting Countries (OPEC).

In recent years, OPEC has shown an ability to manipulate the price of oil around the world, making it unlikely for an increase in U.S. oil production to reduce gas prices. However, this unfortunate fact has a silver lining: OPEC's need to sustain its market base and hold off the alternative energy industry is likely to keep oil prices from skyrocketing.


Two factors tend to be ignored in the discussion on gas pricing.

First, oil markets do not behave as other commodity markets do, such as corn or soybeans. The world market for oil uniquely involves the OPEC cartel controlling the world supply of oil and thus controlling the price of oil by increasing or decreasing production. (During internal quota negotiations in 2008, OPEC members clashed on whether to adjust production to increase prices or just to sustain the price. Subsequently, and consistent with its historical policy, Saudi Arabia vowed to ignore the quotas in order to stabilize the price.)


Second, it is difficult to imagine U.S. political support for imposing an export control system to prevent the oil produced domestically from being sold abroad (e.g., nationalization of oil extraction, a tax — or retention — on oil exports or a legal embargo to the world).

Now, consider this pair of scenarios: 1) The U.S. buys less oil from abroad; as a result, OPEC would cut production and increase prices again (that's what cartels do). 2) The U.S. increases oil production to the extent that it stops buying oil abroad; OPEC would cut production and keep the world price high. In both cases, U.S. consumers would end up paying the OPEC price because U.S. producers (in the absence of trade restriction that would create an isolated market) will export at the higher OPEC price instead of at the lower U.S. price.

It should be remembered that in 2011, the U.S. became a net exporter of petroleum products — and that this development contributed to higher prices at the pump. This is more evidence of a global market where OPEC-controlled oil prices have a direct impact on U.S. gas prices: U.S. companies find it more profitable to sell the additional production abroad, at prices driven up by OPEC, than to bring the U.S. price down by selling domestically. Again, the only quick solution — nationalizing oil production or imposing trade restrictions — would be unacceptable in a free-market system.

While this may seem dire for U.S. consumers, it does not mean that OPEC holds all the cards. As a Saudi oil minister said in 1973: "The Stone Age didn't end because we ran out of stones." In other words, the Saudis understand supply and demand and the historical evolution of technology. If something was learned from the aftermath of the 1973 oil crisis, it is that high oil prices lead to technological solutions, reducing the dependence on oil at a global level (e.g., conservation, development of alternative energy sources, opening of new oil reserves). In some buildings, you can still see "turn off the lights when leaving" signs from those days.

As a result, some OPEC members have been concerned about high oil prices prompting conservation and development of alternative energy sources. Following this logic, the market likely holds a ceiling for U.S. gas prices. According to current estimates, if the average price of gas breaks the $5 barrier at the pump, cars powered by hybrid engines and alternative fuel sources would become less expensive to buy and operate than those powered by internal combustion engines. Thus, one can argue that it is in OPEC's interest to keep the price of gasoline below $5 a gallon. The technology is available, increased demand for the technology would make it more accessible. One would expect OPEC to act accordingly.

Rafael Corredoira is an assistant professor of management and organization at the University of Maryland's Robert H. Smith School of Business.