Here’s why.
Powered by the iffy situation in the Persian Gulf, the Strait of Hormuz,
and the Gulf of Oman, with attacks on tankers and now the downing of a US
drone, the price of crude oil got a little nervous in recent days. WTI jumped
about 6% today to over $57 a barrel.
But this was just a minor uptick in the overall scheme of things: The US,
which has become the largest oil producer in the world, is in the middle of
its second oil bust in five years:
These two oil busts are largely a consequence of surging US crude oil
production. During the oil bust of 2014-2016, the price of WTI collapsed by
over 75%, careening from $107 per barrel to a low of $27 per barrel in 18
months, before starting to rebound. In the process, a slew of oil-and-gas
drillers filed for bankruptcy.
For a while it looked like the shale boom, where all the growth in
production had come from, was running out of money, and therefore out of
fuel. Production fell sharply from early 2015 through much of 2016, but then
new money from Wall Street appeared, and production began to soar again,
hitting new records all along the way.
Shale wells produce a variety of liquid hydrocarbons (they also produce
gaseous hydrocarbons which are not included here). This production of crude
oil and petroleum products soared from just over 7 million barrels per day
(bpd) in 2010 to 16.6 million bpd currently, according to EIA data:
This surge in production comes even as shale oil-and-gas drillers have
essentially been cash-flow negative in their entire history, drilling more
and more of their investors’ funds forever into the ground. But so far so
good — as long as it’s not my money.
The US used to be the largest net importer of crude oil and petroleum
products in the world. Between 2005 and 2008, “net imports” (imports minus
exports) of crude oil and petroleum products exceeded 12 million bpd. But
surging production in the US has slashed imports. And recently exports have
surged, and the trade in crude oil and petroleum products is now nearly
balanced between the US and the rest of the world. And the net imports are
heading toward zero – the point where the US imports as much as exports.
In February, net imports were down to just 176,000 barrels a day, the
lowest in the EIA data going back to 1971. In March, the most recent data
available, net imports were 842,000 barrels a day:
The fact that the US imports a lot of crude oil and petroleum products,
even as it exports a lot too, is related to a variety of factors and market
conditions.
For example, California is the fourth largest oil producing state in the
US, but it’s not enough. It’s not connected via pipelines to producing
regions east of the Rocky Mountains. So it gets some oil by oil train. It
imports oil from Alaska. And it imports the rest from other countries.
But California’s refineries also export gasoline to Mexico and
other countries – try to explain this to Californians who groan under high
gasoline prices! This mismatch of supply and demand, lacking infrastructure,
and global factors plays out across the US and leads to a mix of imports and
exports.
The US has become a huge oil producer despite the cash-burning
characteristics of the shale oil business. But the fact that the shale oil
business burns so much cash makes it a large contributor to the US economy as
every dollar that gets “burned” is spent in the US and gets recycled in the
US economy.
The jobs are well paid. The business has a large high-tech component,
involving highly paid technology employees and contractors, along with
expensive specialized tech equipment and software. In addition, it involves
sophisticated heavy equipment in the field that is fabricated in factories
around the US. It involves transportation to get this equipment and supplies
to the oil field. It involves the construction of infrastructure, such as
pipelines and oil storage facilities, processing facilities, and the like.
Oil-and-gas related industries and their suppliers weigh heavily in US
industrial production and manufacturing, but also in services such as
engineering.
Back when the US was the largest net-importer of crude oil in the world,
any increase in the price of oil siphoned most of this money out of the US
economy to oil-producing countries. As consumers and businesses had to shift
spending dollars from US products to products based on imported oil, a big
surge in oil prices – the “oil shock” – could trigger a recession.
This picture has now completely changed. And Fed Chair Jerome Powell made
note of it during the post-meeting press conference on Wednesday.
While there are some strengths in the US economy, such as services and
consumer spending, he said, there are also some weak spots, particularly business
investment and manufacturing production. He listed a number of factors,
including “lower oil prices.” They not only contribute to “lower investment,”
but also to lower manufacturing production as purchases of new equipment are
put on hold.
This is already showing up. The plunge in oil prices since August has
caused the oil-and-gas sector to get skittish with capital expenditures this
year, and Powell picked up on that. Investment in the US shale sector has a
big impact on the real economy.
This became apparent during the 2014-16 oil bust when the sector
drastically cut back on investing. The overall economy started to slow in
2015, and in 2016, GDP growth was just 1.6%, the worst since the Great
Recession. When the shale patch recovered, economic growth accelerated.
A higher oil price, say over $75 a barrel, would unleash investment in the
US oil patch, and it would unleash orders for new equipment and services.
When companies invest in US shale oil, it triggers a whole chain of
activities in the real economy.
Then Powell touched upon the other side of the coin of lower oil prices:
Consumers pay less for gasoline. Conversely, they would pay more for gasoline
when oil prices are higher. Consumers hate paying more for gasoline. But here
is the thing:
Whatever amount consumers spend on gasoline is part of “Consumer Spending”
which accounts for about 70% of GDP. So, when gasoline prices rise, consumers
with limited budgets shift some of their spending from Walmart’s imported
doodads to gasoline. In this scenario, gasoline sales would rise a lot and
Walmart doodad sales would fall some, and it would all flow into “consumer
spending.”
But gasoline in the US is now mostly a made-in-the-USA product (see the
trade data above, third chart), and most of the money spent on gasoline goes
into the US economy, and stays in the US economy, and is not siphoned out by
OPEC or other producing countries.
Imported doodads siphon money out of the US economy (imports are a
negative value in the GDP formula). So every dollar a consumer shifts away
from imported doodads to gasoline ends up boosting the overall US economy –
though it might slow China’s economy a tad.
Obviously, there are dark consequences of higher gasoline prices: For
example, they may also shift dollars from things like food and healthcare to
gasoline. Higher gasoline prices make consumers surly, and squeeze spending
on discretionary things, such as movies or restaurant meals. But they’re all
shifts within “consumer spending.”
If the price of WTI goes back to $75 or $80, there will be a flood of new
investment in the oil patch in the US. This spending would flow into
manufacturing and services. It would flow into wages. It would flow into
trucking and tech. It would ricochet around the US through the multiplier
effect. Now that the US is the largest oil and natural gas producer in the
world, higher prices for these products are actually beneficial to the
overall US economy, just like they are beneficial to OPEC. This is a new experience
for the US.
For six months now, folks said the Fed had made a “U-turn” and would
cut rates at the “next” meeting, etc. But none of it happened — and might not
happen. Here’s why, in Powell’s words. Read… What
Powell Really Said about the Economy and What Would Trigger a Rate Cut
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