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The Impact of Low Oil Prices on North America

By Frank A. Verrastro

May 14, 2015

For nations that both produce and consume large volumes of oil, a significant (and sustained) price drop necessarily presents a mixed bag, carrying both positive and negative implications. Some of these impacts are evident immediately, while others take a bit longer to manifest themselves. Such is the case for countries in North America, which are all substantial oil producers and consumers, importers and exporters.


This is one of seven briefs in the series "Regional Perspectives on Trends in Global Oil Markets." Read the briefs online:

China
Kang Wu
Facts Global Energy (FGE)

India
Manish Vaid
Observer Research Foundation

Indonesia
Satya Widya Yudha
House of Representatives of the Republic of Indonesia

Japan
Tomoko Hosoe and Osamu Fujisawa
FGE Japan

Russia
Ekaterina Grushevenko
Russian Academy of Sciences

South Korea
Younkyoo Kim
Hanyang University

North America
Frank A. Verrastro
Center for Strategic and International Studies

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Regional Perspectives on Trends in Global Oil Markets

The United States

In the last several years, the United States has been the largest source of incremental global oil supply growth. Although rig counts and price remain substantially below levels of a year ago, oil and gas production has so far remained remarkably resilient. Largely as a result of investments made in previous years and the refocusing/high grading of drilling efforts to the most productive basins, well productivity has continued to grow even as rig counts have declined. The desire to maintain income streams and contract terms that require leases to be held by production continue to spur ongoing development, albeit at a slower pace. According to statistics published by the U.S. Energy Information Administration (EIA), March production in the United States averaged some 9.32 million barrels per day (mmbd), the highest level in 40 years.

At issue, however, are the questions of how low prices can fall and, more importantly, how long they are likely to remain at depressed levels. The duration of the price trough has severe implications for future investment and output in the second half of 2015 and beyond, given the steep decline rates associated with unconventional production. In recognition of cash flow concerns, drilling budgets have been slashed, expenditures have been curtailed, and the drilling of ”research” wells, which had become a common practice to better understand the reservoir dynamics of unconventional basins, has all but been eliminated.

In March 2015, the U.S. economy added 126,000 jobs—the lowest monthly increase since December 2013 and substantially below economists’ expectations. [1] So far this year, employment in mining, the category covering the oil and gas sector, is off some 30,000 jobs. In contrast, the sector added over 40,000 jobs in 2014, mostly in service-related positions, which are typically the easiest and first for companies to cut when prices, income, and profits decline. [2] According to the U.S. Bureau of Labor Statistics, since December 2014, oil and gas firms have announced 91,000 energy-related job cuts, and state and regional impacts are uneven. [3]

The prospects for reversal anytime soon are not bright. Absent a major supply disruption or political upheaval—an eventuality that is not out of the question given insurgency in Yemen, distress in Nigeria and Venezuela, and continued instability in Iraq, Syria, and Libya—or a resurgent rise in economic growth and oil demand, the second half of 2015 looks equally bleak for producers. Add to that the likelihood of incremental new supplies coming online from Iraq and Iran, as well as quick-cycle U.S wells, and you have the makings for a persistent price slump while we work off the current surplus. On the demand side of the ledger, the EIA now forecasts stronger economic growth in 2015–16 than that experienced in 2013–14, in no small part due to reductions in energy costs. Average household expenditures are projected to fall by some 17% in 2015. [4] Lower global oil prices also mean reduced prices paid for imports. (The United States still imports approximately 7 mmbd of crude and an additional 2 mmbd of refined products.) Estimates suggest that lower oil prices will translate into energy and fuel cost savings of $750–$1,000 for the average American household, although so far these savings have not translated into increased consumer spending elsewhere.

Canada

The assessment for Canada is similarly mixed. In testimony before the House of Commons Finance Committee in February, Rhys Mendes, an economist at the Central Bank of Canada, told members that the ”rapid fall in oil prices will have both positive and negative effects on different sectors of the Canadian economy.” He noted that even though real GDP grew by 2.4% in the fourth quarter of 2014, the real incomes of Canadians contracted because the value of an important Canadian export (oil) had also declined. Mendes’s testimony also emphasized the regional impacts and relationship of energy-related supply chains, noting that ”30% of all goods supporting the Alberta oil sands come from other provinces.” [5]

Mexico

For Mexico, a significant but smaller producer and consumer, the impact of low oil prices is more complex. In the midst of widespread economic and energy reform, the precipitous downturn in prices was both inopportune from a timing perspective and also unwelcome in terms of prospective revenue streams. On the positive side, imports of lower-priced oil and gas from the United States into the Mexican economy can also be beneficial. On a macro level, Canada and Mexico both benefit from U.S. economic growth. The bigger energy-related issue for all three countries is the duration of the price trough and the manner in which prices rise on the back end.

Energy and Environmental Security Outlooks

From an environmental and energy security perspective, the discussion of low oil prices is more nuanced. Depending on demand elasticity, lower oil (and gas) prices should in theory stimulate additional oil demand, while at the same time reducing the economic attractiveness of higher-priced but less polluting forms of energy, like nuclear and renewables. This is not a good outcome from an environmental perspective. Additionally, lower gasoline prices tend to make the purchase of hybrid, gas-powered, or electric vehicles less attractive. While public policy choices—e.g., mandates, tax incentives, and HOV-lane accessibility—can be used to partially offset this economic advantage, the opportunity to displace or replace liquid petroleum fuels in transportation is likely to be delayed. Further, with low oil prices the economics of expensive liquefied natural gas (LNG) projects also come into question.

On a foreign policy, national security, and energy security basis, lower oil prices tend to reward low-cost producers, the bulk of which remain the conventional oil producers in the Middle East. Lower U.S. and Canadian production volumes reduce the proportion of output from secure nations, increase reliance on suppliers located in less stable areas, and increase the likelihood of future disruptions and underinvestment, thus leading to price increases going forward.

Some foreign policy enthusiasts have opined that increasing U.S. oil production would substantially enhance the United States’ leverage in dealing with allies as well as competitors and adversaries. Proponents of this view argue that U.S. supplies could replace those of the Middle East or Russia. I tend to view that perspective more as attractive political rhetoric than substantive fact. For while the United States is now the world’s largest oil and gas producer, it is still a significant oil importer, and is likely to remain so for the foreseeable future. Security comes in many forms, not the least of which include having a robust global market, strategic stocks from which to draw prompt barrels in times of significant shortfalls, and policies that support balancing prudent and timely development of indigenous (fossil and renewable) energy resources with environmental stewardship, economic improvement, strong trade ties, and a future-oriented outlook (as the energy landscape continues to change).

Policies aimed at supporting those objectives would include the elimination of consumer subsidies, the promotion of R&D and the adoption of more resilient and sustainable energy forms, the timely approval and construction of needed delivery infrastructure, the dissemination of continued best practices, elimination of barriers to exports, assistance to foreign governments in designing and realizing free-market regulations, and prompt recognition of the desirability of putting meaningful prices on carbon and water, just for starters.

The rise in unconventional oil and gas has expanded the opportunity pool of future supply, added more nations to the mix of prospective and potential producers, and already altered global energy flows. This will likely extend the life of fossil fuels, and for a time lower prices to the benefit of consumers everywhere. As with all depletable resources, however, underinvestment now is likely to bring unpleasant consequences in the future. We are still in the very early stages of this development, and multiple outcomes—not all desirable—have yet to be identified. Historical energy supply-demand relationships between nations will inevitably continue to shift, intraregional trade may expand at the expense of longer-haul trade, and geopolitical alliances may be altered as a consequence.


Endnotes

[1] Bureau of Labor Statistics, U.S. Department of Labor, ”The Employment Situation—March 2015,” March 27,2015.

[2] Sarah Portlock, "Economists React to March Jobs Report," Wall Street Journal, April 3, 2015.

[3] Paul Davidson, "Cheap Oil Prices Chop Jobs by Thousands," USA Today, March 31, 2015.

[4] U.S. Energy Information Administration, "Effects of Low Oil Prices" (presentation at the Center for Strategic and International Studies, Washington, D.C., February 26, 2015.

[5] Gordon Isfeld, "Low Oil to Have 'Both Positive and Negative Effects' on Canadian Economy, Ottawa Told," Financial Post, March 12, 2015.


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Frank A. Verrastro is Senior Vice President and James R. Schlesinger Chair for Energy and Geopolitics at the Center for Strategic and International Studies in Washington, D.C. He has held senior positions in both policy and operations in government and industry.