Oil Production and Global Interdependence

If nothing else, the global pandemic is highlighting the interdependence of the global economy, and hopefully the need for international cooperation. Global oil production is yet another example of this interdependence.

https://www.washingtonpost.com/business/2020/04/10/trump-mexico-oil/

The first oil well in the world was drilled in the United States in 1859; we have been pumping it out of the ground ever since. It was just a few decades ago that many experts believed the United States had already reached and passed “peak oil”, that we had already extracted most of the oil in our country and as a result US oil production would continue to decline. This decline in US output had any number of effects. It increased our reliance on foreign oil and our trade deficit. Oil wasn’t discovered in Saudi Arabia until 1938; they still have plenty of easily extracted oil in the ground. The number of US oil related jobs was shrinking. It led to ever increasing prices for a barrel of oil, with the United States and an ever-larger number of industrialized countries bidding up the price of oil on the global market. The cost of a barrel of oil peaked at $147 in 2008.

But different things happen when the cost of a commodity increases. Buyers find ways to use less of the commodity or find replacements for it. US import tariffs on sugar lead to an increased use of corn syrup as a food sweetener. Increased cost of oil caused consumers to buy more fuel-efficient cars and be more careful with their driving. Power plants and manufacturers found ways to increase efficiency or shift to lower priced natural gas. Fleet operators purchased natural gas-power trucks.

The supply side also adjusts – sellers try to find ways to increase supplies of the commodity to take advantage of the market. In the United States, the increase in global oil prices led to an increase in fracking. Injecting high pressure liquids into the earth caused trapped oil to be released and extracted. In 2008, US oil supply actually began increasing again, because of fracking. The cost of producing a barrel of oil using fracking was much higher than a traditional well, ranging from $40 to $90 a barrel. However demand and price were so high that the United States enjoyed a fracking boom, increasing our annual domestic oil production to over 10 million barrels a day by 2018, more than we had ever produced.

But the United States wasn’t the only country to introduce fracking, or to increase oil production – lots of countries and private companies responded to the high prices by finding new oil fields, or increasing production, or introducing better extraction technologies. Suddenly from a world with too little oil, we became a world with more oil than demand. With the recession of 2008, oil prices dropped down to the $100 a barrel range. US production kept increasing, along with world production, and the price kept dropping, down to the $30 dollar a barrel range. While this was great for US consumers, it was hard on the oil companies that had invested billions of dollars in fracking – suddenly it cost more to produce the oil than it was worth.

And now, in the midst of the global pandemic, oil prices have collapsed even further. Global demand has dropped as economies shut down. And countries that depend on oil revenues to support the government, like Saudi Arabia and Russia, have had to continue to pump oil out of the ground to pay their bills. The price of a barrel of oil has dropped as low at $21, a price not seen in decades.

Saudi Arabia has been working to convince all global oil producers to reduce their production, to attempt to prop up pricing. But every country has a different situation. Mexico, as an example, pre-sold much of its oil at $49 a barrel – it has no incentive to reduce production. But without Mexico, the world’s twelfth largest producer, Saudi Arabia is going to have a harder time getting other oil producing companies to agree to output reduction.

And so President Trump has stepped into the process. He is promising that the US will reduce its oil output, to make up for Mexico’s refusal to cut production. In the United States, the government does not control oil production – President Trump can’t order a reduction in US oil production. But US oil producers have already significantly reduced oil output – for many oil fields, it now costs more to extract the oil than the oil is worth. But if global oil output is reduced and prices start going up, that trend is going to be reversed. US producers will turn back on more oil wells, and production will again start to increase.

President Trump has put himself in a strange position. He has suggested the federal government controls something it doesn’t control. He has also suggested that Mexico will “make it up” to the United States for reducing its oil output, even though the government had nothing to do with the reduction, and Mexico, of course, has a track record of not paying for things the president says it will pay for. And if Saudi Arabia does manage to reduce global supply and the price starts going up, President Trump will be in a strange position. He either has to pretend he never promised the US would hold down its production, or he is going to have pressure US oil manufacturers to reduce oil output – and oil related jobs – to meet the promise he made.

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