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Telling the Simple, Hard Truth About Domestic Oil Drilling: It Doesn't Matter

Deron Lovaas's picture
Deron Lovaas 5,916
, NRDC

I joined NRDC after working for several other conservation groups and Maryland's Environment Department. I was a foreign service kid, born in the Philippines and the living in Nigeria...

  • Member since 2018
  • 68 items added with 26,142 views
  • May 4, 2011
  • 814 views

With wrongheaded bills offered in the House of Representatives as described by my colleague David Goldston, I think it’s worth reviewing evidence of the effect of drilling on how much we pay for gasoline every day.

First, there is the basic question of the possible effect of bringing additional supply online assuming all other factors remain constant (which is foolish, but I’ll get to that). This requires looking at the new Outlook from the Energy Information Administration (EIA), as writer Ben Jervey did here. It takes years for new drilling to come online, just as it takes years for our vehicle fleet to turn over to a more efficient one, so Ben did the logical thing — he looked out to 2025 and contrasted the effects of more efficiency and more driling in the Outlook. The upshot is that a 60 mile-per-gallon average for new autos by 2025 could ease the price at the pump by 20 cents. A scenario maxed out with offshore drilling, on the other hand, could cut the price by a mere five cents a gallon.

Economists and energy experts from across the political spectrum agree that any possible effect of drilling on prices would be delayed, and miniscule. Thanks to the diligent staff at Media Matters, which has taken the time to interview such experts, here are a couple of noteworthy quotes:

  • Tom O’ Donnell, Professor of Graduate International Affairs at The New School: “The amount of extra oil that the U.S. would produce would have an “almost insignificant” effect on prices. [Phone conversation with Media Matters, 3/14/11]
  • Fadel Gheit, energy analyst at Oppenheimer & Co.: “[o]nly the naive would think that (the deep water moratorium) would have a direct impact…it doesn’t even move the needle. Is 100,000 barrels (a day) going to make a difference? It’s not. A cent or two per gallon? It might. But there are much bigger factors.” [FactCheck.org, 3/24/11]

In order to have an effect on prices, as my colleague Brian Siu says, the U.S. needs to make a credible claim about spare production capacity being available. This is highly unlikely, given not just geological realities but economic behavior of the oil industry. It is also worth keeping in mind that another, much bigger player in the world market — the Organization of Petroleum Exporting Countries or OPEC — could trump any additional U.S. drilling by closing its spigots. Energy economist Philip Verleger put this most bluntly in a recent inverview: “Suppose the U.S. were to boost production 1 million barrels a day…OPEC has the capacity to cut 1 million barrels.” [Greenwire, 1/4/11]

The bottom line here, though, was recently and startlingly admitted by Ken Green of the American Enterprise Institute, and Doug Holtz-Eakin (economic adviser to John McCain). Holtz-Eakin’s statement was captured by Joe Romm on his blog here. Ken’s words are worth reprinting, because they are the simple, hard truth:

  • “The world price is the world price…Even if we were producing 100 percent of our oil…[if prices increase because of a shortage in China or India]…our price would go up to the same thing…We probably couldn’t produce enough to affect the world price of oil…People don’t understand that.” [Greenwire, 1/4/11]

The oil market is globalized with prices “discovered” through a complex set of interactions between futures traders, benchmark prices for types of crude oil, geopolitical considerations, currency exchange considerations and other factors. We could only increase drilling modestly, with a substantial time lag, and other factors are unlikely to stay the same so it wouldn’t dent a global price anyway. As I’ve written about before, we’re already drilling like crazy, more that all other nations combined, and yet we consume more than twice what we produce. And we have real-world examples that show that changing that ratio so we produce more won’t unshackle us from a volatile, giant oil marketplace — Canada and the UK.

“Drill baby drill” is a nostalgic, foolish bumper sticker. It’s time to get real about energy independence, which can be achieved with tools such as fuel-efficient vehicle technology and development of clean, renewable substitutes (so it’s no longer a strategic commodity).

Let’s get to work.

Photo by justin2004.

Discussions
Geoffrey Styles's picture
Geoffrey Styles on May 4, 2011

Deron,

Unfortunately, not many of those “economists and experts from across the political spectrum” have actually traded oil, and so they tend to underestimate the impact of marginal production increases (or decreases.)  It’s certainly true that the oil price is set in a world market.  In fact, it’s a classic stock-and-flow system in which the key factors are consumption on the one side and production, inventories and spare capacity on the other.  As with most markets, the price is set at the margin, so an extra million barrels per day of US output should be compared not to the whole 88 million barrel per day market, but to the last 5-10 million barrels per day that actually determine the price. In that context, an extra million or two barrels is significant, as we saw when the Alaskan North Slope ramped up in the 1980s.  And Mr. Verleger’s notion that OPEC could offset any US production increase by reducing its quotas is only half-right, because of the impact of spare capacity on price.  Less spare capacity, higher prices (as we saw in 2007-8); more spare capacity, lower prices (as we saw in 2009.)  That has been a key factor in the recent uptick, as Libya went offline and Saudi Arabia increased output, and it would have the opposite effect if OPEC cut back to accommodate higher US output. The difference wouldn’t vanish, but would shift from production to spare capacity, expanding the cushion for the market. 

“Drill baby drill” is no silver bullet, because even an extra 2 million barrels per day would not eliminate our need to compete for imports with developing nations that are increasing their oil consumption by such large increments, nor would it come on-line quickly, as you note.  However, if you’re buying a lot of oil from other suppliers, it’s always better to have more of your own on hand when you’re negotiating.  And whatever the effect on price might be, the impact on our trade deficit would be dollar-for-dollar. 

Deron Lovaas's picture
Deron Lovaas on May 4, 2011

Thanks for the comments.

First of all, the key word about possible effects on price is “could” since unpredictable geopolitical and/or economic factors could easily trump such relatively modest changes.

Having said that, our hand is stronger on the demand moderation front. We simply have more clout as a buyer (where our unmatched 19-million-barrel-a-day habit gives us monoposonistic leverage) than as a seller (since domestic production has pretty much peaked despite unparalleled exploration and development and while we are #3 on the production list OPEC controls a monopolistic 40 percent of production capacity).

Second, as my colleague Brian Siu has written regarding spare capacity in the U.S.: “Oil production decisions are based on long-term expectations, not short-term volatility. Producers evaluate the costs and benefits of potential projects including drilling costs, the volume of oil that might be produced, infrastructure, long term energy price assumptions and so forth. If the potential returns justify it, the producer will consider moving ahead with the project. But it will not invest in infrastructure, only to idle it for an unknown duration. That would incur all of the costs but none of the revenues, yet that’s what is required for drilling to conceivably dampen the market volatility that drilling advocates use to justify their agenda.” Now, matters might be different if we nationalized the oil industry as several other nations have, but I assume no one advocates that.

Therefore I stand by this and other blog entries I’ve written on this topic recently.

Geoffrey Styles's picture
Geoffrey Styles on May 4, 2011

Mr. Siu’s statement isn’t relevant to this discussion, because of course companies expect to produce the US fields they invest in, at more or less optimal levels (based on criteria such as maximum lifetime recovery or maximum value realization).  The spare capacity I was referring to was not in the US and hasn’t been since the long-gone days when the Texas Railroad Commission, rather than OPEC, set the global price of oil by deciding how much to produce and how much to leave idle.  Today essentially all the world’s spare capacity is in OPEC, with most of that in Saudi Arabia, as the IEA reports in the report I linked in my original comment shows. It works out well for OPEC countries to leave some production idle, because this increases the price on all their barrels, but the trick is compliance.  The lower their output relative to capacity, particularly for member countries with small production relative to population, the more tempted they are to cheatand the weaker prices become.  OPEC’s spare capacity still has an effect on the market, as long as it is perceived as being available to fill in for sudden shortfalls, a la Libya. 

By the way, none of this is intended to disagree with the idea that we can have tremendous influence on the market via conservation. We can. But that fact doesn’t justify foregoing extra production as another response to high and unstable oil prices, particularly when we have substantial untapped resources to draw on. 

Deron Lovaas's picture
Thank Deron for the Post!
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