Making Sense of Mixed Economic Signals: Energy Price Fool’s Gold

US EIA Domestic Oil Production Trend

While world oil prices hover around $100 per barrel, the US is using 2% less energy than its five year average.  Moreover, overall US consumption of oil has been more or less flat since 2004 and down about 10% from 2007 pre-recession highs.  There is plenty of oil in the supply pipeline but prices are volatile.

Oil Economics Reality

Our oil economics reality lesson is that oil price movement has little to do with the actual supply of oil available.  There is plenty of oil today. Oil prices are set in global markets by the actions of thousands of trades each day.  Those prices are decided based upon factors that include the swing in productive oil capacity, the value of the US dollar, global political events that may or may not create trouble, and speculation about whether the future price of oil will go up or down.

Like it or not we are tied to this global oil price phenomenon and oil prices are tied to the value of the US dollar.  The stronger our US economy, the more valuable the dollar and thus the lower the relative price of oil can be to produce the same bang for the speculative buck.

We tell ourselves that while high oil prices still hurt our economy it could be worse.  Our improved energy efficiency is saving us from an even sharper spike in energy prices. There are a few places where that logic is true.  In California, for instance, the systematic imposition of energy efficiency standards the first time Jerry Brown was governor has resulted in energy intensity that is fully one-half the national average. If the rest of the US would adopt, apply and catch up with California’s energy intensity performance we would save a fortune in energy costs.

California prides itself in being green.  We adopt environmental regulations like we mean it and apply them with an intensity that matches.  We are the first in a number of areas.  The first to ban the construction of new nuclear power plants, the first to prohibit our utilities from buying coal fired power from out of state, the first to adopt a 33% renewable portfolio standard.  We were leaders in geothermal and wind and solar before it was fashionable elsewhere.

But we import 20% of our energy from other states.  We pay some of the highest electricity rates with some of the most progressive inclining block rate designs in the nation. And we are beginning to export more jobs to other states than some states create as a result of our onerous environmental and business regulations.

We don’t consume less we just produce less and import more.  As the seventh largest economy in the world California outsources our carbon impact to other states and other nations.  We pay higher prices for many goods and services because they are shipped to us from around the world in a global economy that has become dependent upon substituting higher labor costs for higher energy and transportation costs.

By producing less closer to home are we really doing the planet any favors? Would a cleaner coal plant built in California and run according to our stiffer environmental rules have a greater impact on the planet than the coal plants built in China under must less stringent rules that produce the goods we buy?

We oppose offshore drilling along the California Coast fearful of an oil spill.  Our senators oppose more drilling in Alaska even in the area originally set aside for oil production.  The Alaska Pipeline is beginning to experience maintenance problems because the volume of oil flowing through it as a result of these restrictions causes the oil to cool too rapidly in Alaska’s cold climate and damages the pipeline.

America is accused of paying so much attention to the Middle East in order to protect our access to its oil. Yet a 2006 study by James Murphy, an economist at the University of Alaska Anchorage, and Mark Delucchi at the University of California Davis found that America’s costs to keep oil flowing in the Middle East ranged anywhere between $47 billion and $98 billion per year.  But the amount of oil coming to the United States from the region was worth less than $35 billion per year.

There is plenty America can do to reduce our dependence upon imported oil and other energy supplies.  It requires decisions to produce more energy at home.  Fortunately, America’s technological prowess in developing 3D seismic exploration, horizontal drilling techniques allowing access to more difficult to reach oil and natural gas seams in shales, and hydraulic fracturing to economically recover those resources from unconventional sources is a game changer.  Already unconventional gas production growth in the US has virtually eliminated the need to import LNG from Russia, Quatar and elsewhere.   Today higher oil prices and lower natural gas prices have E&P companies shifting focus to oil with the expectation we will see material increases in domestic oil production as well.  That is exactly what we are seeing in North Dakota, Texas and elsewhere new technologies are being used to unlock access to unconventional energy resources.

The government can help by making energy regulation more predictable. If the government would restore deep water drilling in the Gulf of Mexico and authorize drilling permits in Alaska and exploration along the Atlantic and Pacific coasts America would again be a leader in energy production.  Lower cost, reliable, affordable domestic energy supplies, reduced geopolitical risks and relief from higher transport costs for imports would encourage more domestic manufacturing and job creation.

Higher energy prices undermine higher economic growth rates—what part of this do we not understand?  Getting America’s economic mojo back includes getting back to low cost energy supply from domestic sources to facilitate a rebirth of manufacturing. Doing so is good for America. The best way to reduce emissions is to avoid shipping everything we consume from half way around the world.  The best way to return growth to America’s economy is to make more of what we need at home and keep more of our own dollars working here at home.

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