Donald Trump vs. OPEC

As of last week's price report from the US Energy Information Administration, the average US pump price of regular gasoline has gone up by $0.19 per gallon since the first week of March. That reflects normal seasonal factors but is mainly due to a jump in international crude oil prices of around $8 per barrel in the same period. President Trump's accusation that OPEC is responsible for rising fuel costs shouldn't have surprised anyone:

Last Friday's tweet prompted a quick retort from Saudi Oil Minister al-Falih: "there is no such thing as an artificial price." It doesn't require a deep study of OPEC or economics to conclude that, however phrased, Mr. Trump's remark was closer to the truth than his chosen foil's reply on this issue.

The more interesting question is whether OPEC's very intentional efforts in conjunction with Russia to tighten oil markets are actually harmful to US interests at this point. Could our instinctive reaction to rising oil prices be based on outdated thinking from the long era of perceived scarcity that began with the oil crises of the 1970s and ended, more or less, with this decade's US shale boom?

Let's recall that less than four years ago oil prices fell below $100 per barrel as the rapidly growing output of US shale, or "tight oil" production from wells in North Dakota and South and West Texas created a global oil surplus and rising oil inventories. Oil prices went into free fall around the end of 2014--eventually bottoming out below $30 per barrel--after Saudi Arabia and the rest of OPEC abandoned their output quotas and opened up the taps.

That response to the shale wave began the only period in at least four decades when the oil market could truly be characterized as free, when all producers essentially pumped as much oil as they desired. Some referred to it as OPEC's "war on shale."

However, those conditions proved to be just as hard on OPEC as on US shale producers, and by the end of 2016 OPEC blinked. The output agreement between OPEC's members and a group of non-OPEC producing countries led by Russia has been in place over a year, and it has taken this long to dry up the excess inventories that had accumulated in 2015-16. OPEC's quota compliance--historically mediocre at best--was aided significantly by geopolitical factors affecting several producers, notably the ongoing implosion of Venezuela's economy and the oil industry on which it depends.

Given all this, it's fair to say that OPEC has engineered today's higher oil prices, while its leading members contemplate even higher prices. It's much less obvious that this is bad for the US, which now has a vibrant and diverse energy sector and is finally approaching the energy independence that politicians have touted since the late 1970s.

Prior to the shift in the focus of the shale revolution from natural gas to oil, the US was still a substantial net importer of petroleum and its products. In 2010, we imported over 9 million barrels per day more than we exported. That was around half of our total petroleum supply. Today, these figures are under 4 million barrels per day and 20%, respectively.

That means that when the price of oil rises, this is no longer followed by enormous outflows of dollars leaving the US to enrich Middle East and other producers. Something like 80 cents of every dollar increase in the price of oil stays in the US, and in the short run the effect may be even more beneficial as investment in US production steps up in response.

In other words, when oil prices go up and gasoline and diesel prices follow, the main effect on the US economy is to shift money from one portion of the economy to another, rather than the whole economy springing a large leak. What makes that shift challenging is that consumers come out on the short end, while oil exploration and production companies, and to some extent oil refiners, gain.

A useful way to gauge the impact on consumers is to compare one year's prices to the previous year's. When oil prices were falling a few years ago, year-on-year drops of as much as $1.00 per gallon for gasoline (2014-15) put up to $100 billion a year back into the pockets of consumers. That provided a timely stimulus for an economy still recovering from the financial crisis of the previous decade.

As oil prices started to recover last year, these comparisons turned negative. Currently, the average regular gasoline price is $0.31/gal. higher than last year at this time. If gas prices were to stay that much higher than last year's for the rest of 2018, it would impose a drag of about $45 billion on consumer spending. $2.75/gal. is the highest US average unleaded regular price for April since 2014. Although gas is still nearly $1.00/gal. cheaper than it was then, memories tend to be short.

We may be living in a new era of energy abundance, but I am skeptical that our political instincts have caught up with these altered circumstances. The price of gasoline is still arguably the most visible price in America. When it goes up week after week, consumers notice, even in an economy running at essentially "full employment" and growing at 3% per year.

Most of those consumers are potential voters, and this is another election year with much at stake. In that light, I would not expect President Trump to abandon his attack on "artificial prices" for oil, even if it's arguable that the US economy as a whole may not be worse off with oil over $70 instead of below $60 per barrel.

Should the US Energy Future Depend on Cheap Solar Imports?

The pending administration decision on whether to impose a tariff or other fee on US imports of solar equipment from China raises serious concerns. The right choice in this case is less obvious than suggested by the jobs and free-trade arguments from the main US solar trade association (SEIA) or the Wall St. Journal's editorial page. Solar power generates less than 2% of US electricity today. However, if it is to grow as experts forecast and advocates claim is essential, then considerations such as long-term energy security can't be ignored, while near-term job losses from a new tariff would be more than offset by subsequent growth.

Last October the US International Trade Commission issued its recommendations in favor of the complaint by two US manufacturers of solar panel components. I usually favor low tariffs and open access, especially when the markets in question are functioning smoothly and the principal impacts from trade are the result of "comparative advantage" in production or extraction between countries. However, there is little about the market for solar equipment, including the photovoltaic (PV) cells and modules at issue here, that qualifies as free.

The production and deployment of solar energy hardware has depended since its inception, and from one end of its value chain to the other, on significant government interventions. In the case of China-based PV manufacturing, these have included low-interest government loans, preferential access to land, and minimal environmental regulations. China-based PV manufacturers were also able to take advantage of extravagantly generous European solar subsidies in the 2000s to scale up their output, drive down their costs, and ultimately send much of the EU's solar manufacturing industry into bankruptcy.

On the US end, both solar manufacturing and deployment (installation) have benefited greatly from federal tax credits, cash grants from the US Treasury, and a web of state quotas for aggressively increasing utilization of renewable energy sources. Justified on grounds of energy security, "green jobs", and climate change mitigation, these measures have strongly promoted solar power and  delivered an extraordinary 68% compound annual growth rate in US solar installations since 2006. On a per-unit-of-energy basis, these supports are also at least an order of magnitude more valuable to the solar industry than the federal tax benefits received by the oil and gas industry.

One of the factors that makes this decision so difficult and politically sensitive is that a whole industry has apparently grown up around cheap solar imports, to the point that the main solar benefit to the US economy today is from installation, not manufacturing. US companies and their employees build solar panel racks and other "balance of system" gear, finance rooftop and other solar projects, and construct these installations.

These companies could be at risk of losing business and shedding jobs, if a large tariff were imposed on imported solar cells, modules and panels. Those impacts might be less than feared, though, because the cost of the actual sunlight-converting PV hardware now makes up less than a third of total solar project costs. In other words, a tariff that doubled effective PV cost would drive up total solar costs to a much smaller degree, and least of all for residential solar, which has the highest total costs per kilowatt.

There's another important aspect of this debate that hasn't received much attention. If solar power is as important to our future energy diet as many think, then it should be no more desirable to become heavily reliant on China for our supplies of PV components than it did to depend on growing imports of Middle East oil. That was the main energy security issue for the US for the last 30 years, until the shale revolution unexpectedly reversed that trend. Relying on solar imports from China in the long run will be nothing like depending on Canada for the largest share of the petroleum the US still imports.

It also makes sense to address this situation now, before solar power has grown to 20% or 30% of the US electricity mix, and with the US economy near full employment, when those workers that did lose their jobs would have the best chance to replace them quickly.

From the start, the complaint of unfair competition lodged by Suniva Inc. and Solar World Americas--Chinese- and German-owned, respectively--has been derided as an effort to prop up a couple of marginal players at the expense of the much larger US solar-installation sector. That ignores the position of First Solar (NASDAQ:FSLR), a US-based PV manufacturer with $3 billion in global sales. The company is on record supporting the trade complaint. Of course they aren't a disinterested party; they stand to benefit from a tariff that would raise the cost of competing PV gear from China and elsewhere.

That's precisely the point of the complaint: strengthening US solar manufacturers, so that the growth of solar energy in this country doesn't end up like TV sets and other consumer electronics. There's more at stake, because PV isn't TV. If solar power becomes a major part of US energy supplies by mid-century, it will actually matter if we have a robust manufacturing base to drive its deployment, rather than relying on any one country or region for its key building block.

Iran and Oil Prices in 2018

The turn of the year brought the usual year-end analyses of energy events, along with predictions and issues to watch in the year to come. I tend to focus on tallies of risks and large uncertainties. There's no shortage of those this year, and the current unrest in Iran moves the risks associated with that country higher up the list, at least for now.

The implications of instability in Iran extend well beyond oil prices, but let's focus there for now. The sources of instability include both the internal economic and political concerns apparently behind the protests, as well as US-Iran relations and the fate of the Iran nuclear deal and related sanctions.

As former Energy Department official Joe McMonigle noted, a decision by President Trump to allow US sanctions on Iranian oil exports to go back into effect could remove up to one million barrels per day of crude oil from the global market. He sees the protests making the reinstatement of sanctions likelier. Whether that would lead directly to much higher oil prices is harder to gauge.

A little history is in order. Sanctions on Iran, including those covering the receipt of Iranian oil exports, were one of the main tools that brought its government to the nuclear negotiating table. For a roughly three-year span beginning in late 2011, international sanctions reduced Iran's oil exports by more than one million barrels per day, at a cumulative cost exceeding $100 billion based on oil prices at the time. The effectiveness of those sanctions was also enhanced by the rapid growth of US oil production from shale. 

Starting in 2011, expanding US "tight oil" production from shale began to reduce US oil imports and eased the market pressures that had driven oil back over $100 per barrel as the world recovered from the financial crisis and recession of 2008-9. In the process, shale made it possible for tough oil sanctions to be imposed on Iran and sustained without creating a global oil price shock.

Instead, oil prices actually declined over the period of tightest sanctions. By 2014 US oil output had grown by more than Iran's entire, pre-sanctions exports and cut US oil imports so much that OPEC effectively lost control of oil prices. Seeking to drive shale producers out of the market, OPEC's leadership switched tactics and attempted to flood the market, driving the price of oil briefly below $30. That cut even further into Iran's already-reduced oil revenues and put the country's leadership in an untenable position, forcing them to negotiate limits on their nuclear program. 

If Iran's oil exports were to drop again this year, for whatever reason, the impact on oil prices would depend on the extent to which the factors that allowed us to absorb such a curtailment just a few years ago have changed. One measure of that is that after several years of painfully low prices--at least for producers--the price of the Brent crude global oil benchmark is now well over $60. Yesterday it flirted with $68/barrel, a three-year high. 

That recovery is the result of a roughly 18-month slowdown in US oil production in 2015-16, an agreement between OPEC and key non-OPEC producers like Russia to cut output by around 1.2 million barrels per day, and production problems in places as diverse as Venezuela and the North Sea.

These events have largely put the oil market back into balance and worked off much of the excess oil inventories that had accumulated since 2014. Commercial US crude oil inventories, which are among the most transparently reported in the world, have fallen 100 million barrels since their peak last spring. However, they remain about 100 million barrels above their typical pre-2014 levels. 

Viewed from that perspective, a reduction in supply from any source might be exptected to send prices higher. However, although global oil demand is still growing, we should realize that today's tighter oil market is largely the result of voluntary restraint, rather than shortages. Potential production increases from the rest of OPEC, Russia and the US could more than compensate for another big drop in Iran's oil exports.

In particular, US shale output has been climbing again for the last year, boosted by rising prices and the amazing productivity of the venerable Permian Basin of Texas. Meanwhile, production from the deepwater Gulf of Mexico is also increasing as projects begun when oil was still over $100 reach completion. In its latest forecast the US Energy Information Administration projected that US crude production will reach an all-time high averaging 10 million barrels per day this year. Despite that, US shale producers still have thousands of "drilled-but-uncompleted" wells, or DUCs, waiting in the wings. 

So, short of instability in Iran morphing into a regional conflict involving Saudi Arabia and the other Gulf producers, oil prices might drift higher but would be unlikely to spike anywhere near $100. And that's without factoring in the scenario suggested by the Financial Times' Nick Butler, who proposes that the Iranian government might choose to break the OPEC/Russia deal and increase their oil exports, in order to boost their economy and mollify the protesters, thereby shoring up the regime. 

The last point brings us back from a narrow focus on oil prices to larger geopolitical uncertainties. As a noted Iran expert at the Council on Foreign Relations recently observed, Iran's religious government faces challenges similar to those that led to the collapse of the Soviet Union.

It's far from clear that 2018 will be Iran's 1989, or that President Rouhani is capable of becoming his country's Mikhail Gorbachev. Yet surely the 2015 nuclear agreement was a bet by the US and its "P5+1" partners that Iran would be a very different nation by the time its main provisions start to expire in the next decade. The whole world would win if that prediction came true.

On that note I'd like to wish my readers a happy start to the New Year. My top resolution is to post here more frequently and more regularly than in 2017.