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Oil and Gas Euphoria Is Getting Out of Hand

by Michael Levi
May 7, 2012

The boom in U.S. oil and gas production has spawned another gusher of increasingly hyperbolic claims about its revolutionary consequences. These are not just musings from the fringe; they’re increasingly becoming conventional wisdom, and not just among people who usually pay attention to oil and gas. An essay by David Ignatius in Saturday’s Washington Post, which relies heavily on analysis from Robin West, distills and enthusiastically endorses the emerging CW. I have a lot of respect for both men, but many of the claims that they and others are advancing have become detached from basic economic and geopolitical reality. I want to go through the Ignatius piece carefully and explain why.

The central claim that Ignatius makes is simple: “Dependence on foreign energy, with the threat of supply disruption”, has been one of “America’s greatest economic vulnerabilities in recent time”, but is “on the way to being reversed”.

The figures he presents to support these claims are ambitious but largely defensible. “Because of the rapid expansion of oil and gas production from shale,” he notes, “America is likely to become by 2020 the world’s No. 1 producer of oil, gas and biofuels.” West, he reports, “explains that the natural-gas boom will mean a dramatic change in energy imports and, thus, the security of U.S. energy supplies. He forecasts that combined imports of oil and natural gas will fall from about 52 percent of total demand in 2010 to 22 percent by 2020.” This strikes me as a bit garbled – it is tough to see how the gas boom gets you there by 2020 when the United States barely imports any gas in the first place – but the broader point, i.e. that oil and gas imports could fall from 52 to 22 percent of consumption by the end of the decade on the back of higher oil output and lower consumption, is not unreasonable.

But this is no justification for the claims that follow:

‘This is the energy equivalent of the Berlin Wall coming down,’ contends West. ‘Just as the trauma of the Cold War ended in Berlin, so the trauma of the 1973 oil embargo is ending now.’ The geopolitical implications of this change are striking: ‘We will no longer rely on the Middle East, or compete with such nations as China or India for resources.’

This sort of assertion has become increasingly commonplace among smart people. A few weeks ago, the CEO of Pioneer Natural Resources told the New York Times that “To not be concerned with where our oil is going to come from is probably the biggest home run for the country in a hundred years.” Other examples abound.

Yet I cannot for the life of me figure out the foundation of these claims. How does a shift from 52 to 22 percent import dependence translate into a fundamental reversal in vulnerability? After all, in 1973 itself, only 15 percent of U.S. oil and gas consumption (and only 26 percent of oil) came from imports. If 1973 ushered in a new age of energy insecurity, it is tough to see how a fall in imports to a level still higher than the 1973 one would reverse that.

Moreover, there is no reason to conclude that “we will no longer rely on the Middle East” in any meaningful way. Here’s a thought experiment: imagine that the current confrontation with Iran were taking place in a world where only 22 percent of U.S. oil and gas was imported. Would we no longer be worry about potential oil market disruptions stemming from imposition of sanctions or military conflict? Of course not: we’d be worried about spiking prices and the consequences they might have for the U.S. economy. Lower import dependence would reduce that risk at the margin, but there is zero chance that it would come close to removing it.

The same goes for the claim that we will no longer “compete with such nations as China or India for resources.” How else will we procure the remaining 22 percent (or whatever) of our oil and gas needs? Don’t get me wrong: I’m not suggesting that we’re going to go to war over hydrocarbon deposits. But we’ll be bidding against others (i.e. “competing”) for the marginal barrel of oil, just as we do today.

Some might counter that the problem here isn’t that Ignatius and West have gone too far – it’s that they haven’t gone far enough. What would happen if the United States were to produce all the oil and gas it consumed? Set aside whether this is realistic; it still wouldn’t do the trick. Unless we were prepared to abandon the WTO and NAFTA, shutting the United States oil and gas sectors off from the rest of the world with all the consequences that would entail, we’d still be exposed (though less so than before) to price shocks stemming from Middle East and elsewhere, and would still be competing with China and others to buy resources on the world market, even if those were produced from underneath our own soil.

But there is more. Ignatius’s column isn’t just about energy; it’s also about the resurgence of U.S. manufacturing. Here’s how he links the two:

“Energy security would be one building block of a new prosperity. The other would be the revival of U.S. manufacturing and other industries. This would be driven in part by the low cost of electricity in the United States, which West forecasts will be relatively flat through the rest of this decade, and one-half to one-third that of economic competitors such as Spain, France or Germany.”

Once again, these sorts of claims have become increasingly common. Indeed the quantitative assertions are perfectly plausible. But the big picture implications don’t make sense. As of 2010, total sales of U.S. manufactured goods were about five trillion dollars. At the same time, the sector spent about 100 billion dollars on energy. That’s a mere two percent of total sales. You could slash energy costs to zero, and it would barely move the needle for most U.S. manufacturers. There are, of course, exceptions, like some iron, steel, cement, and paper makers. But even these industries care about much more than their electricity prices. Will lower energy costs move things at the margin? Of course they will, and that’s good news. But they are nowhere close to what’s needed for U.S. manufacturing to broadly thrive.

So let’s take a step back, because these disagreements aren’t just academic. They matter for at least three big reasons.

There is a real risk that policymakers, wrongly convinced that surging supply has solved all U.S. energy vulnerabilities, will neglect the demand side of the equation. But the basic reality hasn’t changed: more supply can help, but to fundamentally reduce U.S. vulnerability to the vagaries of world energy markets, we need to rein in our extraordinary (and economically self-damaging) demand.

This is matched by a danger (which I’ve highlighted before) that U.S. policymakers will do odd things if they start to believe some of the more revolutionary claims that are being peddled. For example, the United States is reassessing its military posture around the world. Mistaken beliefs about how much Middle East stability will or won’t matter to future U.S. economic security could distort the outcomes of that sort of process in problematic ways.

I also worry that some policymakers, with the holy grail of energy independence seemingly in sight, will allow their cost-benefit judgments to get way out of whack. People who otherwise would have worried about protecting communities and the environment can become oddly eager to dig up a few mountains or drill through a dozen national parks when someone tells them that another million barrels a day of oil production will fundamentally change the U.S. position in the world. A more realistic view that sees marginal (though potentially large) rather than revolutionary benefits should produce more measured, and sensible, decisions.

Don’t get me wrong: the oil and gas boom is a big deal. It’s spared the United States the need to become dependent on LNG imports, spurred the creation of hundreds of thousands of jobs, helped shield the United States from some of the consequences of high oil prices, and started to drive coal out of the U.S. electricity sector. That should be good enough news without needing to indulge in implausible hyperbole.

Post a Comment 4 Comments

  • Posted by John

    Oil is fungible.

    Supply and demand.

    I’m not an economist, I’m an engineer. But, we won’t be bidding for “just” the 22% (or 52% or 0%) – we will still be bidding for 100%. Our oil majors are going to give us a hometown price break? “We” may be producing enough supply to support 100% of our capacity but we would still be competing against the world on cost.

  • Posted by Will

    The only way to reduce the price of oil is to reduce the demand for oil. That’s not going to happen because the developing countries are increasing their consumption. We can only reduce our cost for oil by not buying oil! We must change energy! Renewable electricity is possible. Wind, solar, geothermal, hydropower and biomass are all alternative forms of energy. Let’s get off the petroleum pipeline!

  • Posted by dan kimbled

    It is absolutely great that the USA and Canada have such newly discovered and utilized resources.

    I realize that liberals such as the author are not as thrilled as I am (I hope to find a new career in the oil and gas industry. I’ll have to work my way up to it, as I am now unemployed, but this opportunity gives me some hope, at least). The dramatic lowering of natural gas prices will have great effects on bring back jobs.

    But, lets not stop there. After the election, lets have Romney and the new republican majorities in the house and senate start to put a damper on the sources of our job losses in the USA.

    Stop letting China steal our technology.

    Stop automatically giving free, no tariff access to American markets. The Chinese dump products here below cost, anyway. And, we just don’t need free trade with every country on earth. Access to the North American market should be carefully monitored and trading rights bargained for with the USA DRIVING HARD BARGAINS. No more giving away our industry, whole industries.

    CUT and GUT the federal government.

    Let states and municipalities go bankrupt, for those which have given away the store to their government workers. Let them renegotiate old onerous contracts within the bankruptcy court.

    Take very stiff actions to criminalize voter fraud, which the democrats have relied on for decades. Men died in many wars to protect our democracy. It is the height of brazenness to allow voter fraud by the democratic party to be treated as a non-event. Anyone associated with voter fraud should be subject to mandatory, major jail time.

    Get rid of illegal aliens in this country. They do take a massive number of jobs away from Americans who need them. Teenagers, in particular, can benefit greatly from many of these jobs the illegals hold.

    Dramatically curtail all immigration. Revamp immigration laws. End the laws permitting a baby born in this country to be granted automatic citizenship. Many games are being played with this.

    There are so many things needed to be done. This is just a few items I can think of.

    BTW, why stigmatize the coal industry. Its a valuable resource. Lets use it.

    Lets get 100% free of non-North American energy.

  • Posted by Oil and Gas Auction

    Oil and Gas are driving forces in today’s marketplace. While renewable energy and solar and other alternative solutions need to be researched, we cannot ignore the demand for oil and gas and the need to become independent of foreign resources. We need to bring jobs back to the USA.

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