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 Could our instinctive reaction to rising oil prices be based on outdated thinking from the long era of perceived scarcity that began with the oil crises of the 1970s and ended, more or less, with this decade's US shale boom?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.

Will Shale Oil Growth Lead to New US Refineries?

• The revival of US oil production is spurring new investments in refineries, including the restart or new construction of small refineries near these resources.
• How well such investments perform will depend on both the longevity of shale oil production and policies concerning its export.

An article on the revival of some mothballed US oil refineries and the possible construction of new ones provided yet another indication of industry confidence that record growth in oil production from US shale deposits isn't just a temporary phenomenon.  Refineries--even small ones--aren't usually quick-return investments. Restarting one or building a new one requires a positive view of future feedstock availability, product demand and other uncertainties.

The number of US refineries has fallen steadily, from 301 in 1982 to 143 last year. Because this mainly involved the retirement of smaller, less efficient facilities, while larger refineries "de-bottlenecked" or expanded, US refinery capacity actually grew over this period. It's generally cheaper to expand an existing facility, leveraging its infrastructure and experienced staff, than building a "grassroots" facility.

The hurdles facing new refinery construction in the US have been compounded by environmental regulations covering permits, emissions and product specifications. The time when a new entrant could simply distill light crude oil, sprinkle in some tetraethyl lead and other additives, and sell a full slate of refined products is long gone. New refineries in North Dakota, Texas and Utah are apparently focused on producing diesel fuel from the shale, or "tight" oil in the Bakken, Eagle Ford, and Uinta shales, respectively, and selling the rest of their output to other refiners or petrochemical plants as feedstocks .

With diesel demand in the producing areas booming, thanks to the needs of drilling rigs and the trucks that haul water, sand and equipment, as well as oil from leases not connected to pipeline gathering systems, this opportunity could last as long as the drilling-intensive shale development does. In other words, the demand aspiring refiners see appears to be linked directly to their source of supply.

Meanwhile larger plants, such as several of  Valero's Texas refineries, are in various stages of investments to enable them to process more light oil, reversing a multi-decade trend of investment to handle increasingly heavy and sour (high-sulfur) imported crudes. As with the smaller refineries, this shift requires high confidence in the long-term availability and favorable pricing of these high-quality domestic crude oil types.

The reasonableness of that assumption depends on the longevity of tight oil production. Large conventional inland oil fields typically reach peak output within a few years and then decline gradually, with long plateaus. Whether shale deposits, with their distinct geology, will follow the same pattern remains to be seen. Despite a few projections suggesting that tight oil output of the major shale basins could soon peak and decline rapidly, most mainstream forecasts suggest a long life for these resources, particularly as the technology to develop them continues to improve. 

For example, in its latest Annual Energy Outlook, the US Energy Information Administration (EIA) anticipates US tight oil production reaching 4.8 million barrels per day (MBD) by 2021, before gradually declining back to levels near today's in 2040. By contrast BP's just-released Energy Outlook 2035 sees comparable growth over the next few years but little subsequent decline, with tight oil at 4.5 MBD in 2035. Meanwhile, ICF International recently issued its Detailed Production Report, projecting shale/tight oil production in the US and Canada to reach 6.3 MBD by 2035, including 1.3 MBD from the tight oil zones of the Permian Basin of Texas.

The other big uncertainty concerning the availability of light tight oil for new or expanded US refineries depends on federal export policy, which I addressed in a recent post. This issue is highly controversial. A quick reversal of existing rules would be surprising, though as the New York Times noted, possible compromises under existing law could facilitate an expansion of crude oil exports beyond current shipments to Canada. While unlikely to dry up domestic availability of tight oil, such measures could shrink the current discounts for these crudes, compared to internationally traded light crudes like UK Brent. That seems less of a risk for small, simple, inland refineries than for larger facilities, especially those near coastal ports.

This isn't the first time investors have considered the need for new US refineries. There was similar interest after hurricanes Katrina and Rita slashed Gulf Coast refinery output for several weeks in 2005, though it ultimately led nowhere. If today's circumstances prove more supportive, it will be because the US hasn't experienced anything comparable to the shale revolution since the 1920s and '30s, when rapid oil production growth was accompanied by a wave of refinery construction, though in a very different business and regulatory climate. If that parallel holds, consumers stand to benefit from the resulting increase in competition.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.