At present, oil extraction in the United States sits at record levels of roughly 13.2 million barrels per day. No wonder oil is so expensive.
Wait, what’s that you say? U.S. extraction at record levels is causing oil prices to rise? Aren’t oil prices a function of supply versus demand? Wouldn’t oil be cheap with extraction at record levels? No, no, and no.
Responding to the first no, U.S.-based oil extraction doesn’t cause oil prices to rise as much as extraction in the U.S. is only possible insofar as the price of oil is abnormally high. The cost to extract a barrel in Texas’s Permian Basin is around $42, while in North Dakota it’s roughly $50-60. By the admission of fracking legend Harold Hamm, when oil dips below $60/barrel, the economics of U.S. extraction aren’t terribly appealing.
Which is how any reader can always calculate a rough estimate of the price of crude based on activity in the U.S. If it’s high, or at record levels, that’s usually a sign that the price of a barrel well exceeds $60. At present oil sits at around $77/barrel. Contrast this with the 1980s.
While the 80s began with oil at around $35/barrel, it subsequently fell to levels as low as $7. Fast forward to the 1990s, as late as 1998 the price of a barrel of crude was $10. Based on these prices, readers can hopefully by now guess the state of energy extraction in the United States: it was near non-existent. When oil is cheap, the economics of stateside extraction vanish almost in total.
The Wall Street Journal’s Gregory Zuckerman reported precisely the above in his book The Frackers. A largely reverential (with good reason) account of the men who very much advanced a novel way of extracting oil, Zuckerman was clear that in the Reagan 80s and Clinton 90s, there was very little oil exploration in the U.S. and there was pretty much no fracking. The simple truth is that fracking only makes economic sense when the price of a barrel is abnormally high. Put another way, oil extraction born of fracking doesn’t render oil cheap as much as oil must be expensive for fracking to make economic sense.
Which brings us to the supply/demand aspect of oil. There’s a simplistic view that all prices are a consequence of supply and demand. This view gives life to the notion that the U.S. must be “Saudi America” in order for energy to be cheap. Drill Baby, Drill, and all that! No. Not at all. And this is not written as a potshot lobbed at oil. Oil is the most important commodity in the world, by far, and without it life as we know it would be defined by grinding poverty for the vast majority of the world in concert with primitive living standards for all of the world.
At the same time, easily the biggest factor when it comes to the price of oil is the value of the dollar in which oil is priced. When it’s weak as it was in the 1970s and in the 2000s, oil is nominally expensive. On the other hand, when the dollar is strong as it was in the 1980s and 1990s, oil is nominally cheap. And when oil is nominally cheap, stateside production becomes a non-starter.
Are we worse off economically when oil is cheap? Plainly not. No reasonable person would say the U.S. economy was sucking wind under Reagan and Clinton, not to mention that no reasonable person would turn their nose up to the sub $1/gallon gasoline prices that were the norm under Reagan and Clinton.
Coming back to the present, oil extraction is yet again logically at record levels given the high price of oil. Which means that in order for U.S. producers to extract a lot of oil, every American must suffer a weaker dollar alongside much more expensive gasoline. It’s a lousy tradeoff. Not only is the notion of “energy independence” an economic bankrupt concept, applied to oil it means that a major majority must be worse off so that a minority can do work that wouldn’t exist under a sound monetary regime.
Republished from RealClear Markets