Of Two Minds – The “Oil Curse” and Splashy PR Announcements of Oil Production Cuts

November 29, 2022

It’s not just the price of oil that matters: how much disposable income consumers have left to buy more
goods and services matters, too.

The Oil Curse (a.k.a. The Resource Curse) refers to the compelling ease of those blessed with an
abundance of oil/resources to depend on that gift for the majority of state/national revenues. The risks
and demands of developing a diverse, globally competitive economy don’t seem worth the effort when the single-source
wealth of oil offers such a low-risk bounty of revenues.

This dependence becomes a curse when the market value of the oil/resources plummets. Having come to depend
on that seemingly inexhaustible source of massive revenues, even states that have set aside prudent reserves soon
find their expenses cannot align down to diminished oil revenues without unbearable political/social pain.

The ideal solution to this problem is to jawbone oil prices higher by splashily announcing major cuts in
oil production and then ignoring the proposed cuts to pump as much oil as possible to restore spending to
politically viable levels.

The problem is every other oil producer is pursuing the same game plan and so production doesn’t actually decline.
As global demand continues sagging in a global recession, oil supply remains at high levels. Since oil and other
commodities are priced on the margin, even modest misalignments of supply and demand can generate huge swings
in price.

There is no real enforcement of heavily promoted production cuts. The pressure on every oil producer is to
assure the world they’re complying to cover the reality that they’re not actually cutting production because
they can’t afford to lose any more revenues.

The price of oil appears to be reflecting the global recession that’s baked into receding stimulus and liquidity
and higher inflation. China’s attempt to secure Zero Covid is also exerting downward pressure on oil demand.
As consumers globally come to grips with layoffs, depleted savings and maxed-out credit cards, demand can be expected
to drop further.

All those who treated themselves to high living (vacations, dining out, etc.) on credit will soon find the noose
of interest payments tightening around their necks, and all goods and services priced on the margin may fall with
weakening demand, decimating hours worked, employment and profits.

There’s another twist to The Oil Curse story: now that the easy-to-get oil is gone, it now requires
massive, permanent investments in future production to keep the oil flowing. Governments seeing their revenues
decline will naturally slash investment to fund the politically essential welfare-graft that enables their grip on power.

Starved of essential investment, oil production inevitably declines, further reducing revenues of oil-dependent states.
This feedback loop is unforgiving: less investment leads to less oil which leads to less revenues which further
squeezes investment.

It’s not just the price of oil that matters: how much disposable income consumers have left to buy more
goods and services matters, too. Put another way: demand can fall below supply for longer than oil producers can remain
solvent.

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