By Anna Mikulska
The dramatic fall in oil prices in the last few months creates considerable concern for US oil production as it could render unprofitable some of the more costly shale activity. A reduction in rig activity invokes possible cuts in employment in the upstream sector, raising the specter of a trickle-down impact. Specifically, lower employment levels in the mining sector could matriculate into the rest of the economy, negatively affecting consumer spending economic growth, particularly in regions that have been fueled by the US oil and gas production renaissance. But, at the same time, for the general consumer, lower oil prices promise economic growth based on lower gasoline prices, rising disposable incomes, and higher consumer spending. Indeed, in the context of energy security, lower oil prices generally contribute to greater economic prosperity.
The drop in oil price, as welcome as it may be to most US consumers, does not lessen the importance of addressing particular policies that are currently in place in the US. One such policy is the current prohibition of US crude oil exports. Indeed, it is a viable option that could potentially mitigate the harmful effect of lower prices on the US producers in the long term, while having no real effect on US consumers, thus preserving the “price at the pump” benefits of lower oil prices.
To begin, rig counts may be sluggish to adjust. Dramatic ups and downs in oil prices are not new, and companies have historically invested in field development with a long run view in mind. This does not mean they will not react to the recent drop in price, but development plans are typically not based on short run movements in the price of oil (for a detailed discussion on what affects the oil production and oil prices see Medlock 2013). Instead, companies are more likely to rely more on their mid- to long-run projections in their decisions on field development. Moreover, scale-back can be delayed to the extent that some production activity is driven by incentive to hold acreage, such as was seen with natural gas directed drilling activity in 2009-2010. Thus, it is likely, barring an even deeper decline in price, that rig activity should remain relatively strong in the current price environment. From this, it follows that the risks to employment and field activity are likely to become a greater concern if oil prices either continue to fall or remain at the current levels for a protracted period.
This begs the question, “what if the drop in oil prices is both profound and long-term?” The full impact to the energy sector is highly dependent on what development costs are currently, and they are hugely heterogeneous across various production plays, as well as how development costs are likely to change going forward. If costs do as they historically have, then expect them to fall if prices remain low. As the story goes, a $20/barrel project in 2000 is an $80/barrel project today, everything else equal, because the cost of developing upstream opportunities has increased significantly over the last decade. Might we begin to drift back? If so, the US upstream sector – shale specifically – might remain strong even as price declines longer term. In any case, this brings us full circle back to the issue of whether or not oil exports should be allowed from the US. If domestic price transparency and commodity fungibility are to be highlighted, then, perhaps paradoxically, less government intervention through ending the longstanding ban on oil exports is the appropriate path forward.
Decades ago, in the name of national security, the US government decided to attempt to shelter the country from extreme fluctuation in oil prices by banning any crude exports except those to Canada. For a long time, the ban has been of little consequence to the US as domestic production was declining and US oil imports were rising. But, all this changed when the shale revolution revived US oil production and triggered a reversal of fortune for the US domestic production outlook. Now, with the price of oil declining, removing the ban on exports could offer a healthier long term view to US oil producers and attract capital into the US upstream sector. Moreover, analysis has indicated that such a policy shift would have no impact on the price of gasoline.
Under the oil export ban, US producers are forced to sell to domestic refineries. If domestic production of light tight oil begins to stress the capacity of US refiners, then domestically produced oil will have to be sold at a discount to domestic refiners. This situation reflects the fact that oil produced from shale is very light while the bulk of US refining capacity is configured to process less expensive, heavy crudes. Because the competitive margin for domestic crudes is the barrel it displaces, as domestic oil production increases, the competitive margin shifts to heavier crudes. But, lifting the ban, while it may cause international prices to decline, will have the offsetting effect of raising the price of domestically produced oil. This offsetting impact will generally favor domestic production.
Additionally, since US gasoline prices are linked to global oil prices (not domestic), the fall in the price of oil around the world will influence gasoline prices to decline not rise, thus encouraging greater consumer activity within the US – the primary tenet of energy security. Therefore, allowing oil/condensate exports could not only ameliorate concerns to domestic producers, but could also help push the US economy towards a more energy secure future.
Anna Mikulska is a Senior Research Analyst at the Center for Energy Studies, Rice University's Baker Institute for Public Policy
