Why the US oil frackers will be having a nightmare until Christmas

Image from telegraph.co.uk

Have you ever been caught between the Devil and the deep blue sea? It seems like US oil frackers, who have developed expensive technology to extract oil from shale, is just about there, and they are unsure what to do next. According to game theory, they should act collectively to shore up prices, but the payoff is huge to the one who reneges.

Here’s the story.

As you know, oil prices have tumbled since last year, which saw record prices of more than US$100 a barrel to today’s price of US$60. A lot of this has to do with OPEC countries keeping taps open for market share, the US now producing its own oil for domestic consumption, and an overall drop in energy demand because of a contracting global economy. A perfect storm of events to cause the fall in oil prices.

This has precipitated the need for US fracking companies to scale down its expansion plans, curbing capacity. Many shale oil companies have gone belly-up because of the sudden drop in oil prices.

All this, you know.

Yet it has come to a point now in the US that the contraction is bottoming out and the recent uptick in oil prices has made some of them more optimistic about the future. Some are also asking if they indeed could start expansion plans again.

And therein lies the rub. The minute one company starts increasing output, more of them will, thereby causing an increase in the supply of oil, leading price to drop once more. Yet, to the company that does increase their output, more of the much-needed revenue will come in. It is a situation where the first to open the taps would be the ones to gain, much to the chagrin of the rest. But the long-term effects of such a move will cause an overall dip in revenue as prices drop.

How does one make decide what to do in a situation like this?

Business is never about oneself only. If we made a decision irrespective of its impact on the ecosystem, we act irresponsibly, and worse, cause more damage in the long run. While business in the past has been seen as a fixed pie syndrome, meaning more to me means less to you, these days it is a constantly evolving matter. The pie can be expanding if we acted conscionably. We don’t have to be anti-competitive; we can be eco-system-friendly. Beggar thy neighbour has never been a good strategy.

Hence, US oil fracking companies should not increase output now. Of course, that would be a painful course all the way to Christmas, when demand is expected to increase due to the cold weather. In the words of Professor Dumbledore in the Goblet of Fire, “Soon we will have to face the choice between what is right and what is easy.” I hope they choose right.

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