Oil prices in the US present a tricky political economy. It is the largest consumer of oil in the world and one the commodities biggest importers, but at the same time, also a significant producer.
The domestically produced oil is medium cost, meaning it is extracted at a higher cost than fields in the Middle East but cheaper than frontier areas like the Arctic. However, politicians prefer mid-priced oil, avoiding price shock for motorists but high enough to sustain domestic production and limiting increased dependence on imports.
The last couple of year’s optimism and complacency have been the characteristics of the political attitude towards domestic production. This could however change. The shale revolution only happened because of high oil prices combined with technical and entrepreneurial innovation. Rising prices and production pushed concerns about energy dependence into the background, but falling prices and production can just as easy bring them back into the spotlight.
For the first time in over five years, US crude imports are up, indicating that Saudi Arabia’s strategy of winning market share against shale producers is working. This is a trend that has been steadily emerging since the middle of 2015. In the 13 weeks ending July 3, 2015, daily crude imports were 7.1 million barrels while in the last 13 weeks daily crude imports had risen to about 7.9 million barrels. The reason for this increase is twofold; there is strong demand from US oil refineries and domestic oil production from shale operations has been dropping. On top of that, crude is also being imported to store in tank farms because the United States has the physical infrastructure to do so. The trend is expected to continue because refineries are expected to increase production to satisfy record gasoline demand and consumption and US crude production is projected to continue its decline. This growing gap between domestic refining and production is fueling increased imports of crude and refined products.
Saudi Arabia’s strategy of gaining market share might be working but is not without peril if it pushes this too far. It was not that long ago that the rise of oil production and the corresponding drop in oil imports were seen as an important achievement on the road to energy independence. Although energy independence is mostly an illusion in today’s current global economy, it has improved the sense of energy security.
A continued price war and the fallout for domestic producers is bound to generate a political backlash eventually. In 1986 for example, then US vice-president Bush warned Saudi Arabia that oil price stability was a matter of US national security. Bush stated, “There are two edges to this sort of falling prices, and one of them has got to be the fact that this country – our country, the United States of America – has always felt that a viable domestic oil industry is in the national security interests of the United States.”
Meanwhile, Saudi Arabia maintains that its current price strategy is not aimed at shale oil producers. Saudi Arabia’s oil minister Ali al-Naimi recently said at CERAWeek in Houston in February in front of an audience of US producers, “Let me say for the record, again, we have not declared war on shale or on production from any given country or company. We are doing what every other industry representative in this room is doing. We are responding to challenging market conditions and seeking the best possible outcome in a highly competitive environment. Efficient markets will determine where on the cost curve the marginal barrel resides.”
This argument is more than likely lost on struggling US shale oil producers and US politicians alike. Though so far energy issues have had little impact on presidential and congressional campaigns. The Democrat’s base is at best lukewarm about fossil fuel production and more interested in renewable energy issues. Hillary Clinton, for example, has proposed tougher conditions for fracking operations while her rival Bernie Sanders does not support fracking at all.
Since fracking now makes up half of US oil production, this is not a very practical position. Meanwhile, the Obama administration is adopting tougher regulation for all domestic fossil fuel production.
Most oil and gas producing states lean towards the Republican Party already though some like Pennsylvania and Ohio are swing states. The Republican Party, however, is too busy at the moment dealing with the rise of Donald Trump and maintaining its control over Congress. Like in 2012, it is doubtful whether the fossil fuel industry can make energy security and domestic production an election issue. But politics in an election year are always very much in flux, and the drop in domestic oil production might rear its head in unexpected ways after all.