Ed Hirs is a Lecturer in the Department of Economics at the University of Houston. In addition to teaching, Hirs is Managing Director for Hillhouse Resources, LLC, an independent E&P company developing onshore conventional oil and gas discoveries on the Texas Gulf Coast.
He spoke with The Fuse about U.S. economic dependence on foreign oil, the state of the shale industry, and the risks associated with reliance on OPEC.
U.S. transportation relies on petroleum for more than 90 percent of its needs. Why does this dependence make the country’s economy vulnerable?
The short answer is that the U.S. is a net importer of crude oil. We rely upon foreign producers for as much as half of our daily consumption. The world oil market is a very homogenous market. The law of one price holds. So any interruptions in oil supplies around the world are instantly reflected in price changes, whether in Cushing, Oklahoma, in the North Sea, or at the docks in Iran. My interest goes back to President Eisenhower’s view that the U.S. did not want to be dependent on foreign supplies. He saw, in 1959, the way events were going in the Middle East and instituted an oil import quota. The quota was removed by President Nixon at a time of high inflation, when he wanted less expensive crude. However, the Arab Oil Embargo occurred almost immediately afterward to drive oil prices up while President Nixon’s wage and price controls were in place. U.S. producers could not ramp up domestic crude production because they could not pass along their higher costs. The gasoline lines were caused by refiners shutting down production because they were unable to pass along the increased cost of crude. But, with the end of the embargo, the less expensive foreign crude competed effectively with domestic producers and increased our dependence on imports.
Can we isolate ourselves from the world market?
Not at all. We are one of very few countries that can protect supply lines of military personnel around the world.
It’s important that we protect supply chains around the world for our own economic and national security, since an interruption could lead to a significant price increase on the world market.
It’s important that we protect supply chains around the world for our own economic and national security, since a supply interruption could lead to a significant price increase on the world market.
When the price was at $100, my co-authors and I estimated that a severe supply disruption could triple the price, which would have been catastrophic for the U.S. economy, as well as the world economy.
Energy and oil security are not on people’s radar as much now with prices in the $40s. Do you see a danger in that?
I think there is a danger. I know it’s on the radar for the military. I know it’s on the radar for large buyers of refined products. But it’s not on the radar of most consumers, and they don’t think about it until they start finding it expensive at the pump.
How does shale complicate the issue of oil dependence? The U.S. still imports large amounts of crude from the global market, but the U.S. is also a big producer, making oil output an increasingly important part of our economy.
When the Saudis took aim at the shale producers in November 2014 and ran the price down, they wiped out more than $250 billion of U.S. capital.
When the Saudis took aim at the shale producers in November 2014 and ran the price down, they wiped out more than $250 billion of U.S. capital. They wiped out 250,000 direct jobs in U.S. oil and gas. They wiped out 200,000 direct jobs in Alberta alone. They wiped out around $200 billion in annual U.S. GDP. The domestic oil patch was put at an economic disadvantage because of the actions of another country. The shale plays are obviously important to the economy of the U.S. The problem is that in a worldwide commodity market, it’s never an advantage to be a high-cost producer. Shale is high-cost production and it is the marginal barrel in the global market. If prices go high enough, more shale can be dialed up very quickly. The producers know where the oil is. It’s essentially storage in place. Many have turned away from conventional plays, which actually offer better risk-reward profiles and better return-on-capital profiles than shale.
Why are companies turning more toward shale than some of the bigger projects?
On a risk-adjusted basis, producers would be better served to go back to conventional oil and gas.
Wall Street believes that the repeatability and manufacturing nature of the shale plays eliminate the exploration risks from the business. It doesn’t eliminate execution and mechanical risks though. Conventional plays may have a one-in-three probability of success but their payouts could be 3-to-30 times the cost of the wells. On a risk-adjusted basis, producers would be better served to go back to conventional oil and gas.
How would you describe U.S. oil companies’ health in the current environment with prices having stabilized in the $40s?
I am very concerned about the health of the industry. Shale oil companies have been hit hard. Losing $250 billion in capital is not insignificant. Many of the companies have been reorganized and can maintain some levels of production. But even though the futures price is now around $48, that is not what many of these companies are getting in the field. In some of these plays, they’re getting less than $40. Some heavy oils in Wyoming are selling for only $18-$19 per barrel. In the Bakken, the outlook is getting better because of the Dakota Access pipeline, but prices there are still in the low $40s.
Some warn about a coming ‘decade of disorder’ in the global oil market. Do you worry that our strong dependence on oil makes us ill-equipped for such a situation?
There’s always the opportunity for a geopolitical event to cause a price spike. The most dire example would be the sinking of a tanker in the Strait of Hormuz. It is no coincidence that just weeks ago, the Chinese and the Iranian navies conducted joint exercises in the Strait. That is a main focal point since 18-19 percent of the world’s supply goes through it every day. The demand for oil is very inelastic, so cutting that supply would get everybody’s attention.