For the first time in history, the price of West Texas Intermediate, the benchmark standard for US oil, became negative on Monday. This is both a symptom of the catastrophic economic impact of Covid-19 on the world economy and a harbinger of future problems.
It is worthwhile restating the point: the Covid-19 crisis is the worst in capitalism’s peacetime history – bigger than the 2008-9 Great Financial Crisis, bigger than the oil price shocks at the end of the 1970s, bigger than the Great Depression.
It is bad in a way no other crisis in the last 200 or so years has been because it strikes at the fundamental relationship under capitalism, which is the relationship between capital and labour (and nature).
Because of how the virus is transmitted, it is necessary to prevent normal human contact occurring, or risk death on a massive scale and the disintegration of healthcare systems. Social distancing has to be imposed, but this radically disrupts most activities, including – critically – work. Social distancing imposes a rule on how and where work can be performed not as a result of capitalism’s own division of labour, but as a result of direct intervention.
Every other part of the crisis stems from this fundamental disruption to labour – from the collapse in demand from falling incomes, to the deepening financial crisis. And because the disruption is so fundamental, it is unlikely to be resolved without restructuring and reorganising the economy on a grand scale.
Some of this will be deliberate, or at least centrally-directed by government, but much of it will be the result of decentralised, uncoordinated action of those in markets responding themselves. In general, we should expect this restructuring and reorganisation to look like an acceleration of tendencies we have already seen in the last decade: greater state involvement in the economy, a reduction in global trade, and a greater use of data – indeed the tech giants’ share prices have skyrocketed in the last few months. The novel elements are likely to centre on the perceived need for biological surveillance in the regulation of labour: contact tracing, temperature checks, heat surveillance at work.
The economics of oil.
The oil price slump is one marker for this process of change. The lockdowns have produced a collapse in the demand for oil, the result of transport almost grinding to a halt. The price collapse is likely to drive significant restructuring of the fossil fuel industry, including bankruptcies – although government action may be used to stave this scenario off.
US shale producers, hugely burdened with debt, are likely to be amongst those clamouring for state bailouts – Donald Trump having already indicated his strong support for the oil industry. Shale production has shifted the US from a net importer to a net exporter of oil, tilting the balance of power in the oil market back towards Washington.
Saudi Arabia has previously attempted, via Opec, to drive US shale out of business – most dramatically in the last half of 2014 by refusing to cut Opec production, thereby pushing the world price down. Saudi oil is amongst the cheapest in the world to produce, so under normal conditions it is nearly always profitable to pump. US shale is more expensive, so by forcing down the price, Saudi Arabia hoped to drive US producers out of business. As ever, oil production is never far from geopolitics.
The underlying economics of oil production are simple. There is a fixed amount of oil available at any given point in the ground. Once a viable well is discovered, it has to be pumped, refined, transported and stored. Each of these operations imposes a cost; pumping and refining are essential, and cannot be avoided if crude oil is to be turned into a useful product. Transport is necessary, since drilling and refining cannot just be done where the oil is needed.
But storage is close to a pure cost: it costs money to store oil, but adds nothing to the process of producing and using the oil. If storage can be kept to a minimum, it is possible to make greater profits. (There are some complications to this, involving the use of contracts for the future delivery of oil, but these are the essentials.) The result is a permanent under-supply of storage space.
As demand for oil has crashed, oil being produced is placed into storage. And as storage space got used up, it became briefly more profitable (or less loss-making) for those holding contracts for the delivery of US oil next month to try to pay someone else to take the oil off their hands. That is the meaning of the negative price that appeared briefly earlier this week.
Yet demand for oil is unlikely to shift any time soon, particularly as the necessity of an extended lockdown becomes apparent. And that means the market will remain, as Goldman Sachs says, “massively oversupplied”. In theory, a low price would encourage greater demand; in practice, because the lockdown is in place, demand cannot shift. And even if, by some miracle, the lockdown is magically and smoothly ended, bankruptcies and job losses alone will continue to depress demand.
Looking ahead, the oil industry cannot continue in its current form if we are to have any hope of addressing climate change: rather than bailing out the industry, allowing it to continue on publicly-funded life support, government support should be offered only to preserve the incomes of those facing job losses, to retrain workers where needed, and to repurpose investments where possible towards low carbon production.
Falling prices and the possible future slump.
But the slump in oil prices indicates a further problem down the line for capitalism: the risk of disinflation.
Since at least the 2008-9 crisis, it has been very clear that capitalism in general – and certainly for the developed economies, like the UK – does not face the risk of rising inflation. The Bank of England has issued £425bn of new money for ‘quantitative easing’ since early 2009, but inflation has remained at historically low levels. Instead, falling prices – disinflation – has been the issue, reflecting technological changes and the incredibly weak position of those in work being able to bargain a fair price for it.
Falling prices might not sound too bad, since it implies most things becoming cheaper over time, but it creates two grave difficulties.
The first is that if you know prices will be lower in the future, you will hold off buying anything today, resulting in lower demand. The second, more troublingly in current circumstances, is that one way to steadily reduce a debt burden is to allow inflation to eat away at the real value of the debt. Put simply, as prices rise, money becomes worth relatively less; if debts have to be paid in money, then it becomes relatively easier to repay the debt as money falls in relative value.
Households and businesses are already heavily in debt, with the threat of a major crisis down the line as payments become due but cannot be met by those with reduced or no incomes. But the government is presently also taking on huge amounts of new debt. Low rates of inflation, or even worse, disinflation, will increase the real burden of this debt.
There are four steps needed to avoid this.
First, protection for incomes of both people and businesses needs to be improved immediately. Shifting the loans-for-businesses scheme towards grants – and making large grants conditional on preserving employment – is critical. A universal basic income, meanwhile, should remove the inadequacies in current income protection schemes.
Second, the promise to issue money to finance government spending by the Bank of England should be extended, with monetary financing offered for longer-term investments.
Third, the government itself needs to make clear, long-term commitments to those future investments, centred on the need to build a more resilient, less environmentally damaging economy based on human values as means of stabilising demand today.
And, finally, the balance of power in bargaining over pay needs to be swung back in favour of labour – as may, in fits and starts, already be happening. Higher pay for workers can help set a floor on falling prices in general. The economic restructuring will happen, one way or another; better for it to happen on our terms.
James Meadway is an economist and a Novara Media columnist.