The Economist: We could take pressure off crude prices
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M. Ray Perryman
The EconomistMarch 2, 2011 | 2,305 views | Post a comment
In the past week, developments in North Africa and the Middle East have put further upward pressure on oil prices. Tensions have spread to other areas, and the potential for a more lasting crisis in the region appears to be growing.
Given this rather grim picture, some pundits are raising the specter of an end to the US recovery. While I would agree that oil is essential to the US economy and higher prices are undesirable from the perspective of national economic growth, I also think it’s a little early to see the current situation as critical for the recovery.
Recent information on manufacturing activity, for example, points to growing momentum. Moreover, while the threats to the oil supply are legitimate (though not to the level factored into the price by speculators), there is still some slack in the system. By slack, I mean ways we could decrease the pressure on crude prices.
Saudi Arabia is a key source of US oil imports, ranking third (after Canada and Mexico). Longstanding OPEC agreements have kept Saudi Arabia from producing at maximum levels, and if needed, that country could pump out an additional 5 million barrels per day, more than twice Libya’s total production and about five times the level Saudi Arabia now exports to the US. Other countries which are so far not threatened also can increase production if needed.
There is also the potential to increase domestic production. As a resident of the Permian Basin (the richest known oil deposit in the continental US), I am well aware of the recent surge in activity. The rig count in Texas stands at about 750, up from an average of 432 in 2009. However, those levels are still significantly lower than in 2008, when the average was 898.
Moreover, this mini-boom is dwarfed by the early 1980s. In 1981, the rig count stood at 1,318, and more than 15,000 oil wells were completed each year between 1981 and 1985. While last year’s 5,392 oil wells completed (not to mention the 4,071 gas wells) is a nice level of action, we still have some room to up the totals. Not to the levels of the 1980s when our fields were new, but substantial nonetheless. Enhanced technology now allows the extraction of resources that were not accessible decades ago.
Other major sources of domestic supply remain in place and could, with appropriate safeguards and policy, be developed if needed. Drilling in the Gulf of Mexico remains on hold since last year’s spill, but companies are close to finishing work on government-mandated safeguard systems to prevent spills and may be able to resume activity soon. The Gulf alone may hold 45 billion in reserves, with additional amounts in other offshore areas. Other major sources of reserves are also available.
While notable, these are dwarfed by the more than 1.5 trillion the US Geological Survey estimates could be developed from oil reserves in the Green River Formation of Colorado. Analysts indicate production from this and nearby oil shales, if developed, could cut US imports in half and fill US needs for two to three centuries. However, they remain largely off-limits to commercial production because of environmental concerns.
Prices have the potential to move upward quickly, as we’ve seen, but they can also move rapidly downward. In July 2008, oil futures topped $145 per barrel due to a combination of conditions (such as supply-demand, speculation, policy, and declining dollar). However, just seven months later, oil futures were selling for less than $40 per barrel.
Even if a protracted regional conflict in the Middle East develops, the huge financial incentives to maintain oil production will work to minimize supply interruptions. On a short-term basis, various nations could step up production and fill gaps. Domestic production levels also have some room to move upward even under current policy conditions. If drilling is allowed in areas now off limits, the US could see drastic reductions in the need for foreign oil. All of that to say that the current situation, while notable, does not suggest any immediate threat to the US recovery.
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.