The Unintended Consequences Of American Oil Production

The Wall Street Journal today included an article by Daniel Yergin about the falling oil prices. The Organization of the Petroleum Exporting Countries (OPEC) met Thursday and decided not to cut oil production. That is a major policy change and will have worldwide impact. The demand for oil is no longer the basis for OPEC’s decisions–now the deciding factors are the surge in U.S. oil production and the new oil supply from Canada.

The article reports:

Since 2008—when fear of “peak oil,” after which global output would supposedly decline, was the dominant motif—U.S. oil production has risen 80%, to nine million barrels daily. The U.S. increase alone is greater than the output of every OPEC country except Saudi Arabia.

The world has experienced sudden supply gushers before. In the early 1930s, a flood of oil from East Texas drove prices down to 10 cents a barrel—and desperate gas station owners offered chickens as premiums to bring in customers. In the late 1950s, the rapidly swelling flow of Mideast oil led to price cuts that triggered the formation of OPEC.

Oil is currently selling at about $69 per barrel after hovering around $100 per barrel for the past three years. The shale oil being drilled in America is still economical to produce with prices between $50 and $69 per barrel, so the lower prices will not drive America from the world market.

So what are the international implications of cheap oil? The Russian budget is funded over 40% by oil, but Putin has built up a reserve of a few hundred billion dollars that will help Russia cope with the falling oil prices. Venezuela and Iran are also negatively impacted by falling oil prices. Just for the record, the building of the Keystone XL Pipeline would have a severe negative impact on the Venezuelan economy–the Gulf Coast refineries would replace the heavy oil from Venezuela with the Canadian oil.

There is, of course, the possibility that OPEC could change its mind in the Spring and cut output, but even if they were to do that, they would only be hurting themselves, as Canada and the United States would simply increase their production to make up the difference.