The Investor's Shelf — one book
Crude Volatility

Crude Volatility

Robert McNally
2017
T3 315 pages · about 5h 15m to read OL19726646Wgoodreads

Argues price stability always required a swing producer or cartel.

Summary

McNally, an energy analyst who served on the National Economic Council, argues that oil price volatility is the natural state of the market and that the periods of relative price stability in the industry's history were produced by deliberate control rather than by market forces.

The historical argument runs through the mechanisms of control. Standard Oil suppressed price swings by controlling refining and transport in the late nineteenth century. After its breakup and the East Texas discovery of 1930, which collapsed prices, the Texas Railroad Commission imposed production prorationing, restricting output from each well to a fraction of capacity and adjusting the allowable monthly to balance supply against demand. That arrangement held American and therefore world prices within a band for four decades. When American production peaked in 1970 and spare capacity vanished, the Commission had nothing left to restrict, and control passed to OPEC. McNally then examines OPEC's record, arguing that it succeeded at price management only when Saudi Arabia was willing to hold spare capacity and absorb the cuts, and that it repeatedly failed when members cheated or when Saudi Arabia declined the role.

The structural explanation is that oil demand and supply are both highly inelastic in the short run. Consumers cannot quickly change their consumption and producers cannot quickly change output, so small imbalances produce large price moves. Without a swing producer holding spare capacity, volatility is the necessary result.

His forecast is that shale, whose investment cycle is faster than conventional production but not fast enough to act as a true swing supply, restores volatility rather than damping it, and that neither OPEC nor the United States will impose stability.

The argument was written before the 2020 price collapse and the 2022 shock, both of which support the volatility thesis. Critics note that McNally gives limited attention to demand-side transition, and that a structural decline in oil demand would change the dynamics his analysis assumes.

Key takeaways 7

  1. Short-run inelasticity of both oil supply and demand means small imbalances produce very large price movements.
  2. Every period of oil price stability was produced by a controlling institution, not by market equilibrium.
  3. The Texas Railroad Commission stabilised world oil prices for four decades through production prorationing.
  4. American production peaking in 1970 removed the spare capacity that made domestic price control possible and transferred it to OPEC.
  5. OPEC has managed prices successfully only when Saudi Arabia held spare capacity and accepted the cuts required.
  6. Shale production responds faster than conventional supply but not fast enough to function as swing capacity.
  7. Investment in long-cycle oil projects requires price expectations that a volatile market does not provide, which sets up future shortages.

Who should read it

Investors and operators exposed to oil prices who need the structural reason volatility recurs and what would be required to suppress it.

Where it sits in the reference 3

Assets
Philosophy
Industries

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