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Rising Oil Prices: How We Got Here

The shale slowdown of 2014-16 subtracted roughly a full percentage point from the U.S. economy’s overall growth rate.

My Economy column last week covered some of the ways the U.S. economy is affected by oil. Changes in oil-related business investment spending now more or less completely offset any changes to household consumption and nonoil investment.

There is not much economic benefit from either higher or lower prices, just a different distribution of who spends what. There are also interesting regional implications. This piece provides some extra context with additional charts.

First, here is the long history of U.S. oil consumption, domestic production, and net imported supply:

(Consumption is estimated as domestic production plus net imports before 1981 and as refinery and blender net input after that. After February, I used averages of the weekly data to estimate the most recent figures.)

Until the late 1960s, U.S. oil production did a reasonably good job of keeping pace with domestic demand. The problem was that demand continued to accelerate after domestic production peaked in the early 1970s. Even as domestic production dropped by nearly 400 million barrels per year, domestic demand soared by more than 1.4 billion barrels. The result was an explosion in net imports from 500 million barrels per year to 2.3 billion barrels per year.

The Iranian oil shock, which pushed oil prices up by 150%, and the global recession induced by Fed Chairman Paul Volcker in an effort to stamp out inflation, combined to crush U.S. oil demand. After hitting roughly 5.5 billion barrels per year in mid-1979, consumption fell to 4.3 billion barrels per year by 1983. U.S. oil demand would not surpass its previous peak until the 2000s.

Initially, the brunt of the adjustment in demand was borne by foreign oil producers. American net imports plunged by about 1.1 billion barrels per year between 1979 and 1982. Unfortunately, the limits to U.S. production had not been overcome, so the gradual rebound in demand after the trough was satisfied entirely by net imports. By the mid-1980s, foreign producers, especially Saudi Arabia, were keen on regaining lost market share and proceeded to flood the market. Prices fell by nearly two-thirds between the end of 1985 and the middle of 1986. The result was a steady drawdown in U.S. production that was more than offset by rising imports.

By 2007, U.S. crude oil production had shrunk by 1.4 billion barrels compared to 1985. Since then, production has roughly doubled to an all-time high of roughly 3.6 billion barrels per year. Demand has grown relatively briskly over the same period, but not nearly as rapidly as supply. As a result, net imports have dropped by nearly 40%.

This growth has come entirely from drilling in shale formations:

The rise of shale has also had an impact on where America’s crude oil comes from. Alaska, California, and Louisiana all used to be major producers. Now they are dwarfed by newcomers such as Colorado, New Mexico, and North Dakota:

These changes in domestic production can also be seen in the U.S. macro data. The following chart tracks direct business investment spending relating to oil and gas:

(The sources are Underlying Detail table 5.4.5U line 21 and table 5.5.5U line 39.)

Capital expenditures related to oil and gas were about twice as large as a share of the U.S. economy in 1980 than at the peak of the shale boom. Some of this can be explained by the depth of the recession in the early 1980s, which suppressed the denominator, but some of it can also be explained by the economy’s response to the fact that the oil price had soared by a factor of nine since 1973.

Even though oil and gas investment is relatively small compared to the U.S. economy, the cuts in capex from the end of 2014 through the end of 2016 were large enough to directly subtract about 0.4 percentage point off the yearly growth rate in gross domestic product.

Another way to track the impact of shale’s boom, bust, and incipient recovery is to compare the growth rate of the U.S. economy against the growth rate of the U.S. economy excluding the four major shale states of New Mexico, North Dakota, Oklahoma, and Texas:

When prices were high and rising, oil-related investment and the associated spending on everything from home building to restaurants meant that the shale states were boosting U.S. economic growth relative to what it otherwise would have been. As that process went into reverse in 2014-16, the shale slowdown subtracted roughly a full percentage point from the U.S. economy’s overall growth rate.

The last point to highlight is the shifting geography of oil investment within the U.S. in the past seven years. The following chart is based on data on active oil drilling rigs from Baker Hughes:

Before the oil price cratered, only about a third of total active rigs were deployed in the Permian Basin. That share has since climbed to 55%. By contrast, the share of rigs deployed in Eagle Ford and the Williston Basin—the two most productive shale basins outside of the Permian—collapsed from 30% to 15%. Besides the lower costs of production, “operators are looking at up to 4,000 feet of rock that could yield oil and gas in the Permian compared to just 30-100-feet target zones in the Bakken and Eagle Ford,” according to R.T. Dukes of Wood Mackenzie.

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