Expensive energy is an economic, psychological, and political scourge. Nominally, gas prices are at a record high. Adjusted for inflation, they could break the all-time record if they rise just another 35 cents. We should be desperately curious to solve this problem; so, that’s what this episode is all about. Today’s guest is Skanda Amarnath, the executive director at Employ America, which has quickly become one of my very favorite sources of research and commentary on economics. He is also the coauthor of an ingenious plan to increase oil capacity in a way that could reasonably bring down gas prices. This episode gets pretty deep into the weeds of policy and oil markets. But it was one of the most educational conversations I’ve had on this show. And I hope you find it similarly stimulating.
In this excerpt, Derek and Skanda discuss Part 1 of Skanda’s three-part plan for how the U.S. government can incentivize more oil and gas production.
Derek Thompson: So you have a plan to solve the problem of undersupply and underinvestment in oil capacity. This is a plan that you hatched with Arnab Datta, who is a friend of the podcast, and Alex Williams at Employ America. It’s a plan designed to give oil and gas companies the certainty to drill. What is your plan?
Skanda Amarnath: Sure. So our three-part plan rests on certainty around first demand and pricing. Second is certainty around financing. Third, which probably [is] not as important as the first two but still relevant, is cost certainty.
Thompson: OK. Let’s kick it off with demand and price certainty. Where should we start?
Amarnath: So it starts with the Strategic Petroleum Reserve, which is how the government is able to store crude oil for the long term. So it actually sticks it in these salt caverns deep underground, and we can store a lot of crude oil. We typically store more than we have right now, but we are trying to release as much as we can to meet current demand, right? So current demand either has to come from existing inventories or current production. If current production isn’t enough, you draw down from your existing inventory.
Thompson: The Biden administration has already released some oil from the Strategic Reserve. I know you don’t think this is sufficient because it doesn’t increase productive capacity in the future. But it’s still helpful, right?
Amarnath: That’s a helpful sign. That’s helpful. But it’s rarely enough when you think about the future trajectory of demand and supply. So there’s actually more to be done in terms of providing the demand in the future that helps give producers more confidence. So producers have seen this boom/bust environment for the last seven, eight years, and they are understandably concerned about what the evolution of that market is going to look like. “If I produce, how am I going to make sure that I’m not left holding the bag?”
Thompson: Tell us how we would do that. What’s our policy tool to convince oil and gas companies that it’s not hopeless to open new wells?
Amarnath: Sure. When you think about how we’re going to avoid leaving producers holding the bag in terms of their decisions now to invest in future production and to make sure that the future production actually is economical, that it actually checks out, that’s where the government’s unique abilities to store crude oil long term can be very helpful, can serve as an insurance, a demand insurance function. So if the government is a buyer of crude oil, and if the government contractually agrees right now to be able to buy crude oil in the future from U.S. producers, there you have the kind of arrangement that actually gives a lot more certainty for a producer to invest today.
Thompson: Let me try to reframe what you’re saying. I think I understand it. We’ve released all this oil from the Strategic Reserve, that’s good. That’s step one. But the problem is we need to bring more oil online. So how do we encourage that? How do we encourage the oil and gas companies to finance the exploration of more oil wells if they’re afraid the price of oil will keep crashing? What you’re saying is the government can come along and be like, “We will promise to buy future oil from you”—the gas companies, oil and gas companies. “We promise to buy oil from you at this price, at no lower than this price,” and that will overcome the uncertainty that these companies feel about the possibility of oil markets collapsing when circumstances change, when the Russian war ends or OPEC changes its mind. Right? Is this the idea, that a price floor is critical in terms of encouraging more exploration and drilling right now?
Amarnath: I think that’s critical, but I’ll just go one step further. The government doesn’t even have to be forcing the producers to sell to the government at a specific floor price. It just has to offer the option. Right? So if you have the option to sell at a floor price, but let’s say global oil markets could be tight for multiple years right now, given what’s going on in Russia. Because of that, prices could stay high. If prices stay high and producers want to take advantage of that by selling in a tight market and prioritize selling to the highest bidder, that option can still be left to them.
Thompson: Right. You’ve called this price certainty, you’ve called it insurance. Others might call it a “put option,” whatever word, whatever phrase you want to use, the point is the U.S. government can guarantee that oil companies can help us right now, can come to the rescue of energy markets today. And they’ll be rewarded with the certainty that someone will buy their stuff for a minimum price.
Amarnath: That’s exactly right. That you could actually create the kind of price certainty, and that price certainty is huge in this market. I can’t understate just how important it is to have some kind of downside protection, how valuable that is to the industry because this is a hypercyclical market, hypercyclical business. If you can provide that kind of downside protection and the option to sell to the government in a time of, call it oversupply, a time of oversupply crisis, that’s just incredibly important to be able to make the financial math work in terms of, “How am I going to actually get a return on my investment?”
Thompson: Just to draw a sharp contrast here. You’ve got Biden out there begging the oil and gas companies to pump more oil because it’s their patriotic duty, and the oil companies are like, “Nope.” So what you’re saying is don’t beg, don’t appeal to the airy virtue of patriotism. If you want them to pump more oil, set a price floor, guarantee return on investment.
This excerpt was lightly edited for clarity.
Host: Derek Thompson
Guest: Skanda Amarnath
Producer: Devon Manze