Academic
economics textbooks always preach on the
law of supply and demand.
When demand falls, prices will drop and
production level will fallaccordingly until equilibrium is met.With the recent oil supply glut and tumbling oil
prices, one wouldreasonably expect a corresponding cut in oil
companies' production.However, the truth could not have been further.
The oil market did not correctin such a manner.The recent quarterly results of shale oil producers show a y-o-y increasein oil production. How is this even possible in the face of declining oilprices?Firstly, shale oil producers had invested heavily during the shale boom inthe previous decade. The cash outlay had already been spent. A measly returnon investment is better than no return on investment. Secondly, theseinvestments were carried out using a huge burden of debt and other huge fixedcost. Production of oil at a low price would still at least enable them toservice their interest cost.
As an individual company, the action to increase oil production appearsrational and makes perfect sense. Collectively, as an industry, it seemsasinine. More oil production would certainly lead to oil prices spirallingdownwards, exacerbating the problem even further, with each producer soldering onto postpone bankruptcy by increasing output with the unintended consequence of dragging prices tounprofitable levels for everybody.As how the oil titan, John D. Rockefeller phrases it in his biography, "Eachproducer, while pursuing self-interest, generates collective misery. Everyman assumed to struggle hard to get all the business, even though in doingso, he brought upon himself and his competitors nothing but disaster."
On a side note, it is worthwhile to note that while John D. Rockefeller hadlived more than a century ago, his lessons on the oil industry are stillapplicable. Human nature does not change and the world very much still runs onoil.
