The Defense Production Act is not a Get Out of Jail Free Card for Bad Energy Policy
When all you have is a hammer, everything seems like a nail. This truism is again relevant as politicians try to combat high oil prices by considering using the Defense Production Act (DPA) to force oil and gas producers to increase production, and thus hopefully lower oil prices. This would be tantamount to opening a Pandora’s Box of bad policy options.
The DPA is a little-known law borne out of Cold War fear that the Soviet Union would start World War III and that U.S. manufacturing would be caught unprepared and unable to retool into a war economy. Essentially the DPA allows the federal government to force manufacturing contracts that are critical to national security. The rationale being that if it was critical for national defense that Ford build tanks, but Ford was making too much money selling cars to care about making tanks, the federal government would be able to force the transition.
The most common use of the DPA is post-disaster relief from the Federal Emergency Management Agency (FEMA), and this utilization is welcomed. After disasters when food, medicine and other supplies need to be directed to disaster relief, FEMA will use the DPA to direct resources to these efforts, and in doing so they shield the suppliers of these products from potential litigation from breaking contracts. A food supplier wouldn’t have to quibble with their consumers about the relative morality of contract breaching versus providing aid, because the government made the decision for them, so the DPA’s use in this regard is uncontroversial.
The DPA is most useful in cutting red tape to increase production for something needed in the near term. In 2020, the DPA was used in an attempt to boost the production of ventilators. Although the government’s success was middling, this fit the envisioned usage of the DPA where a national security or humanitarian need that might not be fulfilled in the current market can be overcome in the near term.
What is controversial, though, is that once in a while a politician starts toying with the idea of using the DPA to help a pet industry, or to force some politically advantageous outcome. Notably, in 2018 President Donald Trump was toying with the idea of using the DPA to force increased consumption of coal. There was no economic, national security or environmental reason for this. Using the DPA in this fashion would have forced a reordering of private capital to an overall less efficient outcome that would have been economically harmful to the American public.
Worse, though, is that if President Trump had been successful in his efforts to utilize the DPA for coal, this would have sent a terrible signal to the entire market that the government—not the private sector—was the true deciding factor in profitability. The effect would have dramatically chilled private investment in the economy, which is the foundation of any free market system. Similarly, using the DPA in such a manner would have rattled competition, which is the driving force for cost reduction in the market. Few would have had faith that their investments were safe from the political ambitions of the president. Hence, a Pandora’s Box of bad policy.
When it comes to currently high oil prices, we are again at a point where politicians are toying with the idea of using the few levers they have to address the problem, regardless of the economic fallout. Like Bilbo Baggins fondling the One Ring and asking himself, “After all, why shouldn’t I?” politicians are drawn to the easy answer of forcing industry to pump more oil. Or, alternatively to the equally bad notion of forcing people to produce more clean energy.
The problem is that the solution to the current oil price issue is for the market to either increase supply, or to reduce demand through alternative behavior or products. The high market price is currently sending signals to investors and producers that they can profitably pursue previously uneconomic opportunities for production. It is signaling investors and entrepreneurs that they should enter the market and start producing oil. It is also signaling to vehicle buyers that perhaps an electric vehicle isn’t such a bad choice after all. The prices are signaling to consumers that maybe they should carpool or take the train instead of a car for that weekend trip. In many ways, the price allows all market participants (that is to say, everyone) to make efficient choices that maximize their benefits.
The effect of using the DPA to increase oil production is that current producers would have to pump more oil, whether the investment is profitable or not. In cases where it makes no sense to produce oil, it would be produced. The lower price means consumers who otherwise would adjust their consumption behavior or become more efficient now have no incentive to. Potential market entrants that would have produced oil or some alternative now lose any incentive to do so. Essentially the policy is assured to do more harm than good, because it completely undercuts the dynamism of the U.S. economy.
For a more concrete example of why this is a bad idea, imagine going back in time to the summer of 2014. Peak oil prices for West Texas Intermediate (the U.S. benchmark) were around $107 per barrel, which after inflation would be the equivalent of $127 per barrel today, which is higher than the current price of $119 per barrel. What would have happened if President Barack Obama had used the DPA to force an increase in production? The incumbent producers would have pumped more oil, prices would have fallen, and the emerging technology of directional drilling into shale formations—which was only profitable under those high prices—never would have had its heyday. Instead, President Obama let the market run its course, oil producers became more efficient and better at utilizing directional drilling, production skyrocketed in the United States, and a year later prices fell to lower than half what they were initially.
Trying to undercut or micromanage the market is a bad move. Letting the market function and allowing price signals to spur innovation is a good thing. The long-term solution to high oil prices is either better production efficiency or the adoption of alternatives. Using the DPA to force an outcome kills those opportunities for economic efficiency before they’re even off the ground.
The only scenario in which the DPA could be an asset is if some unnecessary or uneconomic government policies or regulations were artificially constraining energy production, but they already have the power to remedy such problems without using the DPA. Furthermore, as some politicians are keen to point out, oil prices have been rising since before the Russian invasion of Ukraine, so it is unlikely that the DPA is going to be overcoming a temporary hiccup in production, but rather there is likely a greater barrier to production that the DPA would simply be obscuring. Since U.S. oil production is still below pre-pandemic levels, it is more likely that measures either artificial or natural to economic cycles are the reasons for low production—none of which should be addressed via the DPA.
Image credit: zef art