Despite a collapse in oil prices of 50 percent since summer’s end, Saudi Arabia, whose vast production capacity has enabled that country to modulate world oil prices by adjusting its output, “effectively resigned from that role,” Daniel Yergin wrote in this past Sunday’s New York Times Week in Review. “…OPEC handed over all responsibility for oil prices to the market, which the Saudi oil minister, Ali Al-Naimi, predicted would ‘stabilize itself eventually.’”
For those unfamiliar with Yergin, since at least the late 1970s, he has been a leading expert and author on oil and its intersection with international economics and politics. He writes that the Saudis’ motivation for relinquishing control—a decision which was far from unanimous among OPEC nations—included fear of losing market share if they turned off the spigots, particularly to Iraq, which they view as a satellite of Iran, and to Iran itself, should sanctions end, bringing that country’s million-plus bbls/day back onto the market.
Now, Yergin writes, the US, long ago the “swing producer” of oil, has been granted that status once again by virtue of Saudi Arabia’s abdication.
The US “was once, by far, the world’s largest oil producer and exporter,” Yergin writes. American production peaked in 1970 at 9.6 million barrels a day, but by 2008, had fallen by nearly half, while oil prices had climbed to $147/bbl (raising the specter of peak oil).
Then, technology came to the rescue, in the form of fracking and horizontal drilling. In 2010, writes Yergin, these nascent gas-harvesting technologies were unleashed upon oil, and by 2014 brought American oil production most of the way back to the 1970 peak. That, and slowing world economic growth brought prices from the stratosphere back down to more terrestrial levels of less than $50/bbl.
Yergin expects shale oil producers to find ways to “drive down costs” so that even if oil prices stay well south of $100/bbl, shale oil production will remain strong. He doesn’t speculate what prices will do beyond 2016, short of saying a growing economy may stimulate more demand. (We were unable to reach him for comment, as he was traveling overseas.)
Providing additional perspective in a New York Times “Upshot” column, the NYT’s David Leonhardt says the current nationwide average price of gasoline, $2.03/gallon, is actually more expensive than at anytime during the 1990s. From 1986 through 2002, the inflation-adjusted cost of a gallon averaged $1.87.
Nonetheless, if maintained, the current low fuel cost could lift some financial burden from the middle class on down. Leonhardt notes that political leaders from President Obama to three likely presidential candidates—Hillary, Jeb Bush, and Scott Walker “consider the wage slowdown to be the country’s most pressing issue.” The wage slowdown refers to the fact that American middle class wages have been so stagnant for the last several decades that our middle class is no longer the world’s most affluent.
Leonhardt asserts that energy costs were a major factor behind the wage slowdown. He writes that the beginning of the wage slowdown coincided with the end of cheap gas. But if gas prices hold to current levels, Americans will have an additional $180 billion their accounts this year, he says (that’s about $562 per capita).
(But maybe energy is not such a major factor: the $180 billion represents less than 1.5 percent of personal income. Tufts economist David Dapice blames the wage slowdown more on rising medical costs, globalization and the breaking up of unions, and slack in labor markets. And Harvard economist George Borjas says mass immigration takes a 3-4 percent bite out of income.)
But if gas remains cheap, rising demand could boost prices. Leonhardt notes in the early ‘80s, CAFE helped dampen demand for fuel. In the mid-‘80s, the best selling vehicles were the Chevy Celebrity, Honda Accord, Ford Escort, and Ford Tempo, “all modest size,” writes Leonhardt. But by the cheap oil era’s end, in 2002, the CAFE truck loophole had catapulted the Explorer, the Trailblazer, the Silverado, and the Ram to the top (See Derek’s article on that loophole.)
“Left to its own devices, the energy market will repeat this cycle,” Leonhardt warns, adding that SUV and pickup truck sales in December 2014 had risen 12 percent over December 2013, compared to just 5 percent for cars.
Avoiding this cycle is the logic behind taxing either gasoline or carbon enough to dampen demand, and rebating at least some of that money to consumers, in the form of tax cuts, as Larry Summers and Charles Krauthammer both advocated, and as the Energy and Enterprise Institute has been promoting. Thus, the external costs of both could be internalized without harming the economy.