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The Promise and Peril of Cheap Oil

By on 9 Oct 2015 in notable posts, viewpoints

The Promise and Peril of Cheap Oil

(Foreign Policy) The U.S. House of Representatives is expected to vote on Friday to do something that would have been unthinkable only a few years ago: lift the restrictions on exporting domestically produced crude oil that have been on the books since the 1970s. It’s a topic that is definitely heating up in Washington: During a Senate hearing Tuesday on energy security, in which I testified about the importance of ensuring that the 40-year-old Strategic Petroleum Reserve can continue to be effective in an emergency, the questioning was overwhelmed by senators asking U.S. Energy Secretary Ernest Moniz to lift the restriction. The move, which many U.S. oil producers cheer, comes at a bleak moment for them.

A combination of surging oil supply and economic weakness sent oil prices plummeting in August for the second time in the last year, hitting six-and-a-half-year lows — down nearly 40 percent from their 2015 high reached in May. Although U.S. production has held up better than expected in a low-price environment, thanks to technological improvements and cost declines, U.S. producers have still been hit hard. After seeing output rise some 4.6 million barrels per day (b/d) since 2008 to a peak of 9.6 million b/d in June, U.S. oil output has fallen to 9.1 million b/d and is projected to fall several hundred thousand b/d further next year.

Because oil production from shale wells declines so quickly after initial production, producers must keep drilling new wells to maintain or grow their output. That also means that U.S. shale oil can respond much more quickly to price changes than conventional oil wells, as producers lay down rigs. But that process still takes time, with U.S. production just starting to turn south more than a year after the price collapse began. This, along with several other important factors, has weighed heavily on oil prices. Since OPEC chose not to cut production at its November 2014 meeting, the producer group has actually increased output by more than 1 million b/d. Further pressure on oil prices is coming from historically high global inventory levels, to which will be added the expected return of Iranian barrels to the market when sanctions are lifted.

Lower oil prices are generally good for U.S. consumers and the economy. Gasoline prices are currently at the lowest level for this time of year since 2006 — more than a dollar below where they were at this point last year — and are projected to fall to $2 per gallon by the end of the year. Heating oil and propane costs for the winter are projected to be 25 percent and 18 percent lower, respectively, than last year. Those gasoline savings of nearly $100 per month per household will act like a tax cut for consumers and could stimulate the U.S. economy. (Although initial surveys suggested consumers, nervous about the economic outlook, would rather save their extra money than spend it, a recent analysis of credit card data found they, in fact, spent most of their gasoline savings.)

But cheap oil can also bring unintended consequences.

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