International analysis and commentary

America’s oil dilemma: Are low prices still the goal?

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The hefty increase in oil production in the United States over the past decade, largely due to new reserves being unlocked by advances in shale drilling technology, has dramatically shifted the role of the United States in global energy markets. Starting with President Richard Nixon in 1973, every subsequent US administration has underscored the goal of “energy independence,” but only halting – often fleeting – progress was made toward this aim in subsequent decades. By 2006, net imports of crude oil and petroleum products had reached more than 13 million barrels per day. Strikingly, in December 2018, the United States – perhaps temporarily, but no less significantly – became a net oil exporter for the first time in three-quarters of a century. US oil production stands at over 11.5 million barrels of oil per day, while steady transport sector efficiency improvements have helped to reduce America’s oil appetite on the margins over the past decade.

Shale oil drilling

 

That the United States enjoys a new role in global oil markets is indisputable; what is less clear, however, is what this new role means for the American interest in terms of oil price policy. Should the American President push and prod for lower oil prices, as so many have done in recent decades? Or does the benefit of higher oil prices extend beyond just American oil producers themselves and confer a stimulative benefit on the broader economy? The answers to these questions are not academic, but highly consequential for the market and the global economy, particularly in light of a leader such as President Donald Trump, who has shown few reservations about using his bully pulpit to shape oil market sentiment.

President Trump has tweeted repeatedly on the oil market, on OPEC, and on its putative leader, Saudi Arabia, over the course of 2018. These tweets tended to occur when oil prices were making a sharp upward move, or when prices were generally approaching $80 per barrel. They initially resulted in a material, albeit short-lived downward oil price impact, though even this effect mitigated over time as the market saw that such rhetoric was not yet being complemented by concrete actions, such as a release of supplies from the US Strategic Petroleum Reserve (SPR).

These tweets reflect the traditional paradigm of past US administrations, and a world in which the US was firmly entrenched within the loose coalition of oil-importing countries (also including Japan, South Korea, and European countries) that had an overarching interest in seeing low, stable oil prices. Oil price stability may indeed remain a shared priority for both consumers and producers alike, but the United States now finds itself in an interesting position as both one of the world’s largest oil consumers, and its largest producer. Along with Saudi Arabia and Russia, it increasingly determines the trajectory of the global oil market (albeit in a less direct manner than the others, as individual producer decision making in the US is private and not subject to government control).

Now, in light of surging US oil production and exports, as well as increased efficiency in the use of oil in the economy, many economists are divided on the degree to which low oil prices are a net benefit to the US economy – if at all. Whereas in the past oil price spikes not only absorbed US wealth and thus reduced non-energy consumption, this wealth also was largely sent abroad, accumulating as petrodollars in the accounts of major global oil producing nations. While indeed some of these petrodollars were invested back into US real estate or other assets, this broader recycling was both circuitous and often not broadly diversified. With the US now the world’s largest oil producer, the broader economic infrastructure supporting this industry has also expanded rapidly. The Bureau of Economic Analysis now estimates business investment in petroleum and natural gas structures at around $140 billion annually. While this is less than half of the $300 billion plus spent by US consumers on petroleum fuels, it nonetheless represents a fundamental countervailing force to the economic drag of higher oil prices for consumers.

Moreover, researchers at the Federal Reserve Bank of Kansas City recently found that overall business fixed investment has begun to mimic the oil sector: both fell in the face of the oil price collapse of late 2014, declined throughout 2015, and then rebounded upward again – following oil prices – in 2016. This is a marked change from the past, when the US had far higher net oil imports and was producing less oil domestically; in those cases higher oil price shocks resulted in higher costs of production, reduced profits, and reduced investment across the US economy as a whole. This time around, it was the oil price fall beginning in 2014 that coincided with a broader economic slowdown across the United States. The most recent oil price collapse, occurring swiftly over the fourth quarter of 2018, is predicted by at least one leading macroeconomist to shave 0.3 percentage points from US GDP growth over the coming year.

Of course, it is almost surely too simplistic to assume that any upward movement in oil prices would thus stoke overall US business investment, or that any oil price movement in the opposite direction would automatically dampen it. The US shale sector (responsible for the majority of overall US oil production) is itself a fast-evolving entity, and continues to respond to various stressors. For example, in the period prior to the oil price collapse of 2014, few expected shale to prove resilient to oil prices of $50 or $60. Not only did US shale production survive these levels, it continued to grow rapidly – exceeding all forecasts of the US Energy Information Administration – at these price levels, and accelerated that growth further as prices finally began to rise again throughout subsequent years. The most rigorous analysis available – a recent paper from the University of Pennsylvania Wharton School of Business – shows that oil prices and business investment are increasingly linked, and that rising oil prices accounted for essentially all of the growth in business investment experienced over 2018.

The US shale industry is also consolidating and evolving in terms of how oil profits are utilized. As it becomes more and more clear that prolific US shale oil and gas production is not a fleeting phenomenon but instead a durable trend for the United States, a number of companies are looking to ensure that their broader economic and community impacts continue to underpin, rather than undermine, their social license to operate. An example of this is the Permian Strategic Partnership, launched in late 2018 by 17 companies in West Texas and Southeast New Mexico to invest $100 million in infrastructure and community initiatives throughout the Permian Basin. Such mechanisms provide another channel, beyond the various sectors servicing oil production activity, for oil revenue to be recycled back into the broader American economy.

US leadership, then, faces an increasingly difficult choice about the degree to which verbal intervention in the market, let alone more material interventions such as SPR releases, contributes to the broader US economic interest. In any case, verbal interventions aimed at specific producer countries (or OPEC as a whole) to lower global oil prices seem to have a quickly-diminishing efficacy if not clear in their goals and duration, backed up by the prospect of material US actions, and cognizant of the constraints and interests of key producer countries. Otherwise, there is a danger that the United States looks increasingly like the boy who cried wolf, losing credibility and leverage without a clear sense of what is to be accomplished. Perhaps, as the US grows accustomed to its new role in global oil markets and its fast-vanishing net imports, it will reassess what America’s strategic posture toward OPEC and global oil markets should indeed look like for the years to come.

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