NR Digital

Past The Pump

by Mario Loyola
Exploiting our oil reserves would transform our economy

Driven by new technologies and discoveries — and by rising global demand — America’s recoverable reserves of crude oil are soaring. And U.S. oil production would be soaring, too, were it not for the Obama administration’s systematic effort to reduce it.

To be sure, domestic production is increasing, but only because a historic boom in oil production on private and state-owned land is making up for a significant constriction of production on federal land and federally controlled offshore areas, which in recent decades is where about a third of U.S. oil has been produced. According to the Department of Energy, oil production under federal leases could decline by 100,000 barrels per day or more from its 2010 level by the end of this year. In 2010, the administration issued the smallest number of onshore federal leases in decades. Future declines are built into Obama’s recently announced five-year plan.

Together with Obama’s refusal to approve the Keystone XL pipeline, the forgone North American production could soon amount to as much as 1 million barrels a day. Under rational energy policies, the United States would be on track to double domestic production by the end of the decade. Instead, U.S. daily oil production will have increased by just a few hundred thousand barrels by the end of Obama’s first term, while demand will have increased dramatically in Asia, and OPEC will have achieved the strongest cartel position it has enjoyed in decades.

“Anybody who says we can get gas down to two bucks a gallon just isn’t telling the truth,” the president recently asserted. Yet gas was cheaper than that when he took office and, more illuminating, it hovered around that price (adjusting for inflation) for nearly the entire 20th century. Through depressions and world wars and decades of historic economic expansion, one thing was almost constant: Gas was about two bucks a gallon.

The reason was not that we had plenty of oil until we started running out, but that we always had excess production capacity except when we failed to invest in more of it. A bit of spare capacity ensured that increased demand resulted in increased supply, not increased prices.

Until the last decade, the major exception to the pattern of stable prices was in the 1970s, when a combination of Nixon-era price controls and environmental policies started reducing U.S. production, and Middle East supply shocks pushed oil prices to today’s levels (adjusting for inflation). That led to a brief rush of capacity expansion and increased U.S. production. But the government soon stopped interfering, cartel discipline collapsed among OPEC countries, non-OPEC producers joined the fray, and prices crashed, bringing about the oil glut of the 1980s and 1990s. U.S. production then declined, from nearly 9 million barrels per day in the early 1980s to just under 5 million in 2008, while prices stayed at rock bottom until the very end.

The current period of rising prices is due largely to the historic rise in demand from Asia; its effect on prices was interrupted by the recession. While energy economists cite a myriad of other factors that influence price, the backdrop for all these factors’ interactions is the fact that OPEC countries have satisfied most of the new demand from Asia. A recent industry report projects that by 2030, OPEC’s market position will rise from 40 percent to 46 percent, “a position not seen since 1977.”

The combination of market concentration and high prices is the ideal setting for cartel discipline. Right on cue, Senator Chuck Schumer (D., N.Y.) recently called for the Saudis to ramp up production. But by limiting U.S. production in a period of high prices, the Obama administration is only incentivizing the Saudis to do the same.

The president blames higher prices on “speculation of war in the Middle East,” although that often describes the tenuous state of peace in that region. Yet he would have you believe that increasing North American oil production by 1 million barrels per day by the end of next year — as a sound energy policy might have done — wouldn’t have any effect on global prices.

When excess production capacity starts to vanish (as happened between 2002 and 2005), increased demand results not in increased production but in increased prices. That is called “scarcity pricing,” as distinct from “commodity pricing.” And we saw the opposite effects between 2007 and 2009, when global oil demand declined from a high of 86 million barrels per day to 85 million and gasoline prices fell by half from their peak.

With global demand expected to reach nearly 90 million barrels per day this year, and non-OPEC oil production continuing to decline, the United States, Canada, and Brazil hold the keys to disarming OPEC and bringing prices back down. Indeed, oil historians such as Daniel Yergin think the western hemisphere could become self-sufficient, substantially weakening OPEC’s cartel position.

Increasing domestic production over the next several years would certainly affect gasoline prices now, because expectations of future supply and demand are an important price component today. Conversely, current policies — not speculators — promise years of continued scarcity and OPEC dominance ahead, a guarantee of high prices.

Increasing U.S. oil production by, say, 2 million barrels in the short term would not merely reduce gasoline prices. It would have a historic impact on the U.S. economy. Cheap energy in the form of increased oil and natural gas would make U.S. manufacturing much more competitive abroad, lowering unemployment, increasing income, and reducing the current-account deficit. It is an achievable goal, and we should spare no effort to achieve it.

Displacing 2 million barrels per day of imports would wipe out perhaps a fourth of the U.S. current-account deficit, which would dramatically strengthen economic fundamentals and lead to a significant increase in national income. That would increase tax revenue and reduce the deficit without a tax raise. That in turn would allow investments to come into balance with savings, while increased income and reduced unemployment would make it possible to cut government spending without major adverse short-term effects. The country’s whole economic outlook would improve, and the impact on global energy prices could even spur a worldwide recovery.

Instead, current policies are set to increase the pain for America’s working families in the years ahead. The president says that he sympathizes with them, and we may take him at his word. But he has competing priorities. For environmentalists, limiting production of fossil fuels is an inherent public good, even if it comes at the expense of public welfare today.

President Carter’s National Energy Plan of 1977 sought to restrict oil production, because, the authors said, to do otherwise would mean that “the nation’s economic security and the American way of life will be gravely endangered.” The concern was the dire prediction that world oil would become “very scarce and very expensive in the 1980’s.” Of course, as the political economist Robert L. Bradley Jr. recounts in Capitalism at Work, Malthusian “peak theorists” and depletion doomsayers had predicted catastrophic scarcities just around the corner since the start of the coal era in Britain in the 19th century.

Today, with recoverable reserves soaring, after decade upon decade in which depletion alarmists have been refuted, the concern is no longer that the gas pumps might suddenly run dry. We moved on to saving the planet and slowing the rise of the oceans. And now that it appears increased CO2 doesn’t trap as much heat as we thought (there has been no global warming in 15 years), one wonders what the next doomsday scenario will be.

Regardless, history strongly suggests what the policy prescription will be. In the 1977 textbook Ecoscience, several of the most prominent eco-alarmists of the age called for “limitation of material consumption, redistribution of wealth, transitions to technologies that are environmentally and socially less destructive than today’s, and movement towards some kind of world government.”

Such policies have proven ruinous when they’ve been tried. Protecting the environment does not require economic suicide. The United States finds itself in one of the most precarious economic and fiscal situations of its history, and Providence has given us a natural-resource bounty to work our way out of it. To borrow from current presidential oratory, anyone who says an increase of 2 million barrels per day won’t make a huge difference in our economy either doesn’t know what he’s talking about or isn’t telling you the truth.

– Mr. Loyola is a senior analyst at the Armstrong Center for Energy and the Environment, and the director of the Center for Tenth Amendment Studies at the Texas Public Policy Foundation.

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