Upending Energy Will Result In Unintended Consequences
“In 2020, the U.S. exported more petroleum than it imported - last done during World War II. Freedom from foreign oil gives us greater foreign policy flexibility, which will erode with the Joe Biden’s anti-oil policies. ”
The domestic oil and gas industry has a target on its back. In fact, there is one on its front and on both sides, too. These targets might as well say ‘Kick Me’ because the fate of the industry is to be bludgeoned into oblivion if it does not magically disappear into the netherworld on its own. What underscores this attitude? It is climate change (or now climate emergency) and the perception that we need to abandon the use of fossil fuels. Consultants are raking in big bucks authoring reports telling politicians that demands for a net-zero carbon emissions world are realistic. Of course, the politicians, as well as the media reporting on the studies, seem to miss the ‘coulds,’ ‘likelys’ and other qualifiers that populate the reports and will become the consultants’ defense when the forecasts fail. These reports assume no impediments to the implementation of strategies for net-zero emissions, either from the physical sciences or opposition from the public. In many cases, the targets are reached based on the assumption that the technologies currently missing today to achieve the target will magically be present when needed to completely decarbonize the economy. And the cost is never an issue – if it is even considered.
Last year, for all the turbulence in the energy business, the United States achieved a major milestone last experienced during World War II, or, in peacetime, during the Great Depression. In 2020, we exported more crude oil and petroleum products than we imported. We had achieved “independence from foreign oil,” although the reality is that we continued to import oil from foreign suppliers to obtain the optimal fuel mix for running our refineries. However, the bigger picture of oil export volumes exceeding imports should not be diminished. It was an incredible achievement when one realizes how rapidly it was achieved.
Exhibit 5. Net Oil Imports Has Changed U.S. Foreign Policy SOURCE: EIA, PPHB
The history of U.S. net petroleum imports shows how our energy appetite exploded during the 1960s, at the same time as our domestic oil output was flattening. Gasoline was cheap, cars were big and powerful, and Americans began hitting the open roads. With cars only getting a few miles per gallon, our gasoline consumption exploded. Between 1950 and 1970, daily gasoline consumption grew by 230%, reaching 5.6 million barrels per day. Gasoline at the pump was so cheap that gas stations emphasized customer service (something we only see in New Jersey nowadays) and giving away glasses to attract customers. Homes with oil-burning furnaces were not well insulated, allowing significant heat loss, but it did not materially inflate consumer bills. Utilities burned oil to generate electricity because it was cheap. All of that changed with the 1973 Oil Embargo that drove oil prices from $3 to $12 per barrel in a matter of months, and shortages and long lines at the pump became de rigor. Wow! The idea we were running out of oil began to permeate views of our future. We began thinking of crude oil as extremely valuable, and something that needed to be conserved and utilized in its highest-value applications.
OPEC’s market power set the world on an energy diet. Investment in insulating homes, building automobiles that achieved double-digit fuel economy, turning down thermostats, and making other fuel-efficient lifestyle changes suddenly became important. Every aspect of Americans’ lives impacted by energy use was ripe for change. Energy efficiency and conservation became watchwords for everything that went on in the economy and society. The result was a dramatic fall in oil use, leading to reduced oil imports.
At the same time, the sharply higher global oil price, coupled with government and oil company concerns about creating a more diverse supply of oil (having been victimized by the embargo), drove exploration around the world, resulting in the discovery of new major deposits. The high oil price also motivated OPEC members to cheat on their production quotas to earn more wealth. That cheating grew just as the newly discovered oil supplies began flowing, resulting in a flooding of world oil markets. Despite the best efforts of Saudi Arabia, the titular head of OPEC, oil prices crashed.
From 1985 onwards, with brief interruptions during economic contractions, America’s oil thirst grew again. At the same time, domestic oil output continued to erode. U.S. oil basins were considered mature with few prospects for meaningful discoveries. Large, multi-national oil companies began focusing on the offshore and international markets for their growth. That did nothing for U.S. exports or imports. The world supply glut that caused the mid-1980s oil price collapse assured that prices would remain depressed for years. Low oil prices convinced people that energy costs would continue shrinking as a percentage of consumer budgets. Growing oil consumption and stagnant or falling production marked the 1990s and early 2000s.
Exhibit 6. Changed Relationship Of Oil Imports And Exports SOURCE: EIA, PPHB
After 2005, the successful oilfield techniques of horizontal drilling and hydraulic fracturing that opened and propelled natural gas output was applied to crude oil wells. These technologies proved just as successful with crude oil as they did with natural gas wells. Suddenly, U.S. oil production began growing, in contrast to expectations for continuing declines. Was this a flash-in-the-pan, or was it the start of a new era for the domestic oil business?
As domestic oil output began growing in the mid-2000s, the U.S. economy was further benefitting from a trend that had begun in the late 1970s. That trend was an economy demonstrating increasing energy efficiency in response to the explosion in oil prices during the 1970s. When we measure petroleum consumption per dollar of real GDP, we see how during the decades of the 50s, 60s and 70s, that ratio fluctuated around 100%. During most of that period, petroleum prices were low, providing no incentive to improve energy efficiency. Once oil prices quadrupled in the early 70s, the push for improved energy efficiency kicked off. It took years for companies to design, produce and market more energy-efficient cars, appliances and building materials. The Iranian Revolution in 1978 and the resulting doubling of global oil prices put that energy-efficiency effort into overdrive. From then on, we have seen a steady decline in the ratio.
Exhibit 7. How Energy Efficiency Has Change U.S. Oil Use SOURCE: EIA, FRED, PPHB
This improvement in U.S. economic energy intensity coupled with the growth in domestic oil output drove net oil imports below zero last year. Can this trend continue? Most likely not. The pandemic and its destruction of oil demand, along with prices, has severely undercut oilfield spending and activity necessary to sustain output. According to the latest Energy Information Administration (EIA) data, oil output has fallen by roughly 2 mmb/d, from 13 to 11 mmb/d. With the new financial discipline mantra for managing oil and gas companies, reinvestment rates for exploration and production are now in the 60%-80% of cash flow range, down from the prior 100%-120% range. Even with lower finding and development costs, more productive well completions, and high-grading drilling prospects, it will take years, if ever, to recover that lost production. Transitioning to a decarbonized economy will also impact oil consumption over time. We are likely to be facing a situation where our net import success is eroded, naturally, but it also will be driven down by the Biden administration’s efforts to restrict oil and gas leasing and drilling on federal lands, and even possibly other steps to inhibit petroleum industry growth.
The key message from the net oil imports chart is that we should consider what the benefits of divorcing our economy from dependence on foreign oil sources has meant for the United States. We were able to eliminate our dependence on Middle East oil supplies, which was a powerful reason why the U.S. was actively involved in the region’s politics for decades. Becoming less beholden to Middle East oil has allowed us to adjust our foreign policy in the region and focus on the global dangers from Iran’s support for terrorism against American and western interests.
The Trump administration’s willingness to reject the failed foreign policy tenets of past administrations led to the historical Abraham Accords that commenced a movement to reduce the tensions between Israel and its Arab neighbors and turns the focus towards Iran and its efforts to destabilize the Middle East. The altered world oil balance enabled the U.S. to pressure Iran’s government with sanctions on its oil exports that have nearly crippled its economy. While Iranian leaders have sustained their policy of supporting terrorism around the globe, the cost has been borne by its citizens. At some point, one would hope those citizens will revolt and depose their autocratic leaders, replacing them with ones willing to work with the international community and improve the lives of Iranian citizens. That hope is fading. The Biden administration is desperate to re-engage in the Iranian nuclear agreement that will require ending economic sanctions before proceeding.
Besides the Middle East, U.S.-Russian foreign policy was helped by the reduced dependence on international oil suppliers. Russia’s political power is dependent on its natural resource economy, something it has been using in Western Europe, especially Germany with the Nord Stream II natural gas pipeline. When that line is complete and in operation late this year, Russia’s share of European gas supply will grow, but importantly, it can be sustained at a high level even if Russia loses market access via Ukraine. Russia has strengthened its energy ties with China, and given a more robust commodity market, will also benefit from increased raw material exports. This strength will come despite the Biden administration’s recent Russian sanctions.
The strengthened political negotiating positions in the Middle East and with Russia stem from our recent energy revolution. The ability to increase our political leverage further, and maybe even retain our current leverage, will diminish as our independence from foreign oil suppliers erodes. While market conditions and lower oil prices explain part of the erosion of our energy independence, the Biden administration’s anti-oil attitude will be the primary cause of future erosion. For the first time in 75 years, the U.S. was positioned to redesign its foreign policy from a position of strength. That opportunity will be lost once net oil imports begin rising, an unintended consequence of governing with an anti-fossil fuel agenda.