The Second Coming of the U.S. as an Oil Powerhouse

The U.S. has been producing over 9 million barrels of oil per day through the first half of 2015. Production at those levels has not been seen since the early 1970s – the last time the U.S. was considered an oil powerhouse. Much has changed since that time. The potent combination of hydraulic fracturing and horizontal drilling has opened vast reserves of oil and natural gas that were once believed to be economically unviable. Our main source of imported oil is Canada and not the Middle East. The 77-year monopoly of Mexican state-owned petroleum company Pemex ended this year when it began partnering with foreign companies (including Italy’s Eni) to develop Mexico’s oil reserves.

What does the future hold for the U.S. as an oil powerhouse? It’s too early to tell. But there are some new challenges and opportunities that have emerged over the past 40 years that suggest this go-round will be different.

Oil Export Ban
U.S. crude oil prices are currently $2 to $8 dollar per barrel lower than international prices. Studies from Resources for the Future, ICF International and EnSys Energy, IHS Global Insight, and NERA all suggest that lifting the 40-year old ban on crude oil exports will allow U.S. crude oil prices to rise to international levels. On October 9th, the US House of Representatives voted to lift the ban. Repealing the ban has broad support among Senate Republicans but is lacking Democratic support needed to override a threatened Presidential veto. Much of the stated opposition against lifting the ban has been fear of higher gasoline prices. However, there is little support for this argument. Rising crude oil prices will stimulate production in the Midwest and Canada. This alone will decrease prices for refined products. But lifting the ban has a second benefit. Much of the recent increase in production is in the form of light crude. U.S. refineries are better equipped to handle the heavier crude that was produced in the U.S. in the early 1970s. Lifting the export ban would allow U.S. producers to sell to foreign refineries that are better equipped to handle the light crude. These increases in refining efficiency will lower gasoline prices further. In fact, the Jones Act, a century-old law intended to support the ship-building industry, may have more to do with higher gasoline prices. The Jones Act restricts passage between U.S. ports to ships that are U.S.-built, U.S.-flagged and U.S.-crewed. This makes it cheaper to ship refined products such as gasoline to Europe than the U.S. East Cost. These and other antiquated policies will need to be revisited in this new energy landscape.

Global Economy
A major byproduct of the U.S. becoming a dominant oil producer is that OPEC appears to have (at least temporarily) lost the ability to set a price floor. This suggests that prices can be expected to remain low for some time which may have a number of positive and negative impacts across the globe. To be sure, lower oil prices will be largely beneficial for the global economy though winners and losers in different sectors of the economy will undoubtedly emerge. However, there is the potential for destabilizing effects in many oil-exporting countries such as Saudi Arabia, Russia, Venezuela, and Nigeria. For example, some 90 percent of Saudi Arabian government revenue and 50 percent of GDP is attributed to oil. While many have noted that the increase in domestic oil production will allow the U.S. to disentangle itself from sticky situations in other parts of the world (for example the Middle East), this is not entirely true.The U.S. as a major oil exporter will become even more concerned about the stability of the world economy. This may mean more involvement across the globe especially in emerging economies where destabilization may hurt oil demand. Plus, even if the oil export ban is lifted and the U.S. becomes a major oil exporter, it will still remain a net importer.

Environmental Concerns
At first glance it may appear that increasing production of oil is bad news for the environment. Low oil prices tend to discourage development of renewable energy sources and encourage more oil use. For instance, we are already seeing sales of SUVs and trucks rebound from recent lows and new investments in large wind and solar projects have stalled. But the news on the environmental front isn’t all bad. We may see new energy and climate change policies emerge since such policies are more politically palatable when energy costs are low. For instance, with gasoline prices relatively low and natural gas supplies holding down electricity prices, the impact of introducing carbon pricing or cap and trade policies is relatively low. Ironically, a world with low oil prices may actually allow these proposals to gain traction in Congress.

There are also less obvious impacts on the environmental front. For instance, potential conflicts between oil and gas production and threatened and endangered species have led to more proactive involvement by the private sector to help support species conservation in an effort to keep them off the federal endangered species list. For instance the recent decision to not list the greater sage grouse as endangered (a species whose habitat overlaps many oil and gas fields in Utah and Wyoming) was due in part to pro-active collaboration between industry and environmental groups. The forest products (National Council for Air and Stream Improvements) and electric power (Electric Power Research Institute) sectors have organizations that serve as industry hubs for species conservation research. A similar industry group for the oil and gas sector does not currently exist but may be useful (if not necessary) to stave off potential limits to domestic production from the Endangered Species Act.

Domestic Production Subsidies
According to a 2002 ruling by the World Trade Organization (WTO), U.S. tax law violated the international agreement regarding trade and subsidies by subsidizing manufacturing exports. In response, Congress replaced the illegal tax provision with a domestic manufacturing tax deduction. Congress also allowed oil and gas developers to claim the 6 percent deduction even though oil and gas development is not part of the manufacturing sector. At the time, the U.S. was not a major producer of oil and gas. With the U.S. oil production recently overtaking Russia and quickly catching Saudi Arabia, expect international calls for these provisions to be eliminated. Re-examining these tax credits may shine a light on other oil and gas production subsidies.

Reports by the National Research Council and the U.S. Department of the Treasury both suggest that eliminating these production incentives would have a modest impact on domestic production; perhaps lowering production by about 26,000 barrels per day. It would take less than two weeks to make up for this decline given recent increases in production. However, eliminating these incentives may change the structure of domestic energy markets. One of positive side effects of the recent energy boom in the U.S. has been the re-emergence of small independent producers. Compared to the supermajors, these independent producers rely on cash flow instead of debt to finance new projects. Eliminating domestic oil production subsidies may disproportionately impact independent producers.