Publications: Notes at the Margin

The Saudi Victory; Lessons from the Depression (April 6, 2020)


We cover two topics this week. We begin with a discussion of the Saudi victory. Oil prices jumped April 2 following a tweet from President Trump. In it, he suggested that Russia and Saudi Arabia might cut production by ten million barrels per day or more. This development has been described as a triumph for the United States. Others have written that, in contemplating this reduction, Russia and Saudi Arabia have miscalculated. We disagree with the latter view. By the end of April, we expect Saudi Arabia will have sealed its win over the pesky US frackers. It will achieve its goal by elevating the cost of ocean freight to the point where US producers seeking to export oil will net receipts of around $20 per barrel. The Saudis will have boosted freight rates by chartering most of the world’s available Very Large Crude Carriers (VLCCs).


In tying up tankers, Saudi Arabia is applying an economic approach that is probably unfamiliar to oil market analysts, oil economists, energy policymakers, and company officials. The technique is called "raising rivals’ costs" or RRC. RRC is a subject that is widely known to economists and lawyers who practice antitrust law. A dominant firm may be able to put its competitors out of business legally under certain situations if it can raise their costs. Here, one sees the world’s largest oil producer using shipping as a way to close down the high-cost competition.


Saudi Arabia and other low-cost producers have a strong incentive to act against high-cost producers because history suggests global oil use will decline for several years, which brings us to our second topic. This calculation is based on the evidence from the 1930s. We have assembled data from 1920 to 1941 and attempted to measure the impact of the depression on oil demand. The review has essential lessons for the present because a growing number of macroeconomists think the current downturn could be as severe as the Great Depression.


History shows that oil consumption would have been twenty percent higher in the 1930s absent the Depression. The worry today is that global oil consumption in the 2020s could be similarly affected.


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