On Wednesday I noted that encouraging more U.S. oil production was unlikely to result in a significant drop in U.S. retail gasoline prices. Nevertheless, I believe that there would be some important economic benefits from lowering the U.S. oil import bill, as I discuss here.
In 2011, the U.S. imported $462 billion of petroleum and petroleum products, or more than a billion dollars every day (see BEA Table 4.2.5). The fact that we import goods from other countries is not a problem per se. Standard economic theory teaches that if the U.S. imports some goods and exports others, the country overall will be richer than in the absence of trade, because the value of what we gain in imports is higher to us than the value of what we sell as exports. But in the current U.S. situation, our oil imports aren’t balanced by other exports. Last year the U.S. spent $568 billion more on imported goods and services than we sold to other countries, with petroleum imports accounting for more than 80% of the total current account deficit
When we import more than we export, we have to pay for the difference either by selling off some of our assets or by borrowing more from foreigners. Notwithstanding, running a current account deficit could still be a way to make the country richer. If we use the imported goods and borrowed funds to invest in productive capital and useful infrastructure, we should have plenty of future resources to pay back all that we borrowed, with more left over for ourselves. In such a case, a big current account deficit could still be a win-win situation.
But what if we’re not investing, and are just using the imports and foreign borrowing to enjoy a temporarily higher standard of living, leaving it to the future to pay the bills? That, too, could be economically optimal if what we most value as a nation is having more consumption spending right now.
But I’m not convinced that’s the future that most Americans want.
One can express the magnitude of historical U.S. oil imports in current dollar terms by supposing that each dollar of imported oil since 1973 had ultimately been paid for by selling U.S. Treasury debt to the oil exporters. I took the dollar value of oil imports each year since 1973 and calculated the value if that sum had been invested in Treasury securities which were rolled over up to the present day. That calculation leads to a cumulative wealth transfer since 1973 from the U.S. to oil-producing countries of some $10.3 trillion when valued in 2011 dollars. That comes to almost $33,000 from every person in America or $131,000 for a family of four. And much of that transfer has gone to support causes and regimes that are in fundamental opposition to America’s goals and values.
Aside from the magnitude of this wealth transfer, there are some other limitations of U.S. international indebtedness that should be acknowledged. Whether we want to or not, it can’t go on forever– at some point we’re going to have to reduce our net imports. One avenue by which this could happen would be through a depreciation of the dollar. If this were to come very quickly, accompanied by a sudden capital flight, it could be a very chaotic and damaging transition.
Other economists have raised the possibility that the capital inflows themselves have created some problems. Caballero and Krishnamurthy (2009) and Portes (2009) suggested that the accumulation of wealth by foreigners seeking high-yield but low-risk investments in the United States was an important cause of the proliferation of toxic leveraged assets that proved to be key factors in the housing boom and subsequent bust.
For these reasons, I agree with the position taken by both President Obama and Governor Romney that presidential decisions need to encourage more oil production in the United States.
However, I would add that policies that discourage U.S. consumption of petroleum would also achieve the same goal. For example, trying to make more use of our natural gas resources for transportation is an idea that should appeal to Americans on both sides of the political spectrum.
The presidential campaign has primarily been an effort to convince voters that the other party would be even worse for America than yours. Although that’s a discouraging spectacle for many of us, I retain the hope that, whoever wins the election, they might seize the opportunity to move the country in a more positive direction by focusing on some goals and strategies on which both political parties should be able to agree.
Increasing U.S. oil production and decreasing U.S. oil consumption should be two such goals.
The U.S. trade deficit reflects both the willingness of other countries to lend to the U.S. (in order to increase their currency reserves and net asset positions) and the willingness of the U.S. to borrow from these other country (laughingly called the “strong dollar policy”.)
So long a countries want to increase their holdings of reserve currencies, they will price their goods at a level tempting enough to U.S. consumers, either by weakening their currency or by lowering wages and “investing” the extra profit margins at the corporate level.
The composition of the goods contributing to the trade deficit have no effect on the overall level. If we weren’t importing oil, we would be importing manufactured goods or other commodities. The mix of countries that gain currency reserves might change but that is not a concern of U.S. policy.
Our American problem with oil is primarily overconsumption, not underproduction. This is a direct result of underinvestment in fuel switching, energy efficiency and infrastructure.
There are very clear differences between the Obama and Romney plans for energy.
Obama’s plan includes more oil production, development of alternative energy sources, conservation and carbon taxes.
Romney has only the Palin plan — “drill, baby, drill.” That’s it.
There are real consequences for this election.
Nice argument, but doesn’t your argument about the negative wealth effects of oil imports apply to Canadian imports as well as Saudi imports? Last time I checked Canada was not yet the 51st state, eh.
James,
it is funny you made these calculus. I just did the same for the US with $ and the eurozone with €, on a 10 years basis.
Very surprisingly, in 10 years, the total of oil imports by the US matches the fiat money by the Fed !
http://global-warning.fr/WordPress3/wp-content/uploads/2012/09/Capturer14.png
For the ECB and the eurozone, is is a “little” bit more (there was a lot of natural gas to buy I guess …)
http://global-warning.fr/WordPress3/wp-content/uploads/2012/09/Capturer15.png
Regards,
Michel
I would be very curious to hear your thoughts on when the US should increase its oil production.
I think that producing oil today creates an opportunity cost; one less barrel of oil that can be produced in the future. As with any non-renewable resource, that means we need the benefits of current production against the costs of reduced future production. To do that, we need to consider (a) expected rates of growth of oil prices and (b) the right discount rate for future oil production.
All the analysis I see suggests that (a) is positive, but you know much more than I do about what a reasonable forecast range would be (and how that could be affected by marginal changes in US production).
I also see that, unlike many other nations, the US can borrow at negative real interest rates. Since oil revenues are uncertain, I assume I should discount those revenues at a somewhat higher rate to adjust for that risk, but I’m not sure how much higher.
Taking these two things together, I don’t know the discount rate I should be applying to future oil revenues is higher or lower than the expected growth rate of oil prices. If it is higher, the US if better off increasing current production. If it is lower, the US is better off delaying production and waiting for higher prices before producing.
I’m sure that you’ve carefully thought through this intertemporal problem. What growth rate did you think was appropriate for future oil prices? What risk premium did you use? Can you give us some idea of how much marginal benefit (in present-value terms) the US should expect from moving one barrel of oil production forward to the present?
Simon van Norden JDH may have changed his mind on this (I mean that in a good way, not the Romney flip-flop way), but my interpretation of his writings is that oil prices do not seem to follow a Hotelling price path, as theory would predict. Recently (a few years ago) he argued that oil prices follow a random walk without drift. Sooner or later we should expect reality will sink in and markets will start pricing oil as an exhaustible resource, and then owners of oil reserves will have to start making those kinds of intertemporal decisions you mentioned. Optimal control theory to the rescue! Until that day comes I remain very skeptical that oil prices should be trusted as reliable market signals.
Oil is heavy when looking at the trade data but not only oil, as monetary policies, exchanges rates policies, interest policies have their shares of the tolls.
The balance of trade data as displayed by the Fed Saint Louis are more demanding than oil trade only
In the 90’s traders in foreign exchanges were concerned by a monotone monthly trade deficit of 6/8 billions USD .The same were kept unfazed afterwards after doubling the trade deficit figures and immunized when it almost quadrupled in 2008.
http://research.stlouisfed.org/fred2/series/BOPBM
Balance on Merchandise Trade (BOPBM)
2012:Q2: -185.790 Billions of Dollars Last 5 Observations
Some interventions by the Federal reserve Banks are noticeable in the 80’s and then the great moderation of the Central Banks and a mute life in the Central banks contingent liabilities and in the same registry of the Banks.
http://research.stlouisfed.org/fred2/series/USINTDMRKTOTH
U.S. Intervention: In Market Transactions in Other Currencies (Millions of USD) (USINTDMRKTOTH)
China / U.S. Foreign Exchange Rate (DEXCHUS)
2012-10-12: 6.2670 Chinese Yuan to One U.S. Dollar when US Dollar was appreciating against Yuan from 1980 till 2005;
Trade Weighted U.S. Dollar Index: Major Currencies (DTWEXM)
One may wish to read so handily, the same data base from the ECB
In 2011, the United States consumed about 134 billion gallons1 (or 3.19 billion barrels2) of gasoline, a daily average of about 367.08 million gallons (8.74 million barrels). This was about 6% less than the record high of about 142.38 billion gallons (or 3.39 billion barrels) consumed in 2007.
http://www.eia.gov/tools/faqs/faq.cfm?id=23&t=10
Some of that was a reaction to the economy; some a result of vehicle efficiency.
Natural gas continues to increase as a source of fuel and electrical energy due to domestic shale production.
Meanwhile, coal and nuclear power are being grossly neglected or decremented as sources of energy.
Wind energy is sucking up all sorts of subsidies to make it “competitive” while hardly making a dent in energy consumption fulfillment. Solar? Ha, ha.
We have a “some of the above” energy policy.
Simon –
You pose the question of whether oil resources should be developed by some means other than relying on price signals. While in principle appealing, a non-price approach would be problematic in practice:
Who decides?
If we are to abandon the price signal, who should determine the timing and volume of drilling? The Democrats? The Republicans? Congress? The White House? The EIA? I criticized EIA forecasts in a blog post on Econbrowser some time ago. Do we now assume they have a clearer picture of the future?
How much oil is there?
Five years ago, everyone thought we’d be importing LNG and that US oil production was in perpetual decline. But technology development—technology development driven by smaller, entrepreneurial companies operating outside the industry consensus—revolutionized the business. So how much oil is there? It’s very hard to say, because it depends on both prices and technologies, and these are both fundamentally outside government control. How much shale oil and gas production would there be today if we had relied on the Obama administration to approve each project? Precious little.
Examples Matter
Drill, baby, drill is working. And not just in the US. The reason the Russians, Chinese, Argentines, Poles and others are looking at fracking is due to its stunning success in the US. We lead by example, an example set by maverick independents operating on private lands, not by government or even the oil majors.
Alaska should be a priority
But if we allow policy considerations, Alaska should be one. The viability of the TransAlaska Pipeline may become compromised if flows fall below 300 kbpd. They were 400 kbpd in recent months—and Shell is almost a decade to first oil. If the pipeline loses viability, it must by law be dismantled, thereby stranding Alaska’s resources, possibly forever. Should we make a priority the preservation of the TAPS and its capacity? Should we not then push Shell to pick up the pace in Alaska?
Oil Production is Game Theoretic
If you want the Saudis to produce more, you have to produce more. If oil prices go up, Saudi Arabia can secure its oil revenues without increases in production—which it has. If oil prices drop, then the Kingdom will have to increase production to offset price declines.
Technology will be better in the Future
As I have pointed out, the future belongs to self-driving cars. These now have a legal framework in a handful of states, and Google’s self-driving cars have logged more than 300,000 miles of safe operation. Every major automobile manufacturer is engaged on the topic. Self-driving technology has the promise to make electric cars viable even in the absence of technology improvements. But what makes self-driving cars truly viable as a business model? Your iPhone. Smart phones allow location-based services—like telling your self-driving car where to pick you up. So the enabling technology for self-driving cars is not batteries, it’s your smart phone. And that innovation happened only in the last few years. We are more dependent on oil now than we will be in the future—and that argues to rely more on oil-based fuels today.
To put it all together, abandonment of the price signal as the impetus for increased oil production leaves the decision-making process largely adrift. Every non price-based approach is likely to be worse—almost certainly much worse–than relying on price signals alone.
S. Kopits wrote: “…an example set by maverick independents operating on private lands, …”
Maverick independents operating on private lands, then dumping their toxic waste into public water supplies. Great example! Let’s replicate it everywhere. Drill baby drill, then dump baby dump.
Easiest solution is to stop subsidizing the oil companies with troops in the mideast. I.e., make the mideast defend their own oil production and bring it to us. They would pay for the defense out of the price of oil. Currently we pay for both the oil and the defense of its production and delivery to us.
The market will not allow Romney to increase natural gas production any faster than it is increasing now because currently we have a glut.
http://www.msnbc.msn.com/id/49494494/ns/business-us_business/
And, reading the article, it’s clear that the reason for the glut is again the financial industry over investing in a particular industry, but this time they’ve also loaned their money out with stipulations that the drillers can’t stop drilling. As a result, producers aren’t able to respond to the price drop and the glut continues.
To the extent that there’s a solution to this, it is in increased demand for natural gas by shifting more of our energy use to it. The Obama administration supports a bill that would provide incentives for truckers and city buses to switch to natural gas. Clean air regulations also push utilities to shift from coal to gas. Electric vehicles will potentially allow transportation miles by regular cars to be fueled by electricity produced from natural gas.
How much of this would survive Romney? And even if it does, why should I think conversion will happen faster under him?
Robert –
The flowback from fracking depends on where you are. In much of the Marcellus, there is little flowback (a portion of the fracking fluid). What comes back is treated and retained in lined ponds or sent to Ohio for re-injection to exhausted conventional wells. It puts oily water back where oily water originally came from.
In the west, notably Texas and Oklahoma, re-injection in exhausted oil wells is the standard disposal technique.
There is no practice of “dumping” stuff. It’s possible to treat frac and produced water reasonably well. However, when you’ve done that, you’ll typically be left with highly saline water–which can really only be treated by distillation or osmosis, both of which are expensive. So re-injection tends to be favored.
Arid regions like Colorado can be somewhat more problematic, not so much due to dumping but rather because of draws on a finite acquifer. So there are special regulations in place in these jurisdictions.
If you’re interested in the matter, you might consult the MyCelx prospectus. We provided the market study, and that gives a pretty good overview of produced water market, at least from a volatile organics perspective.
Professor,
I believe you make two related questionable assumptions.
First, you assume that government debt gives the best return on imported oil because recently we have been paying for imported oil with government debt. Actually, if we had a real market driving oil imports and production the oil imports would be paid for with production for either domestic consumption or export. Here the ROI would be higher than government bonds and so increased oil imports would be justified if the imports drove increased production. In other words better policies toward producing businesses would justify higher imports.
The second assumption is that the President should determine investment. No government entity can make investment decisions better than the market. Hayek speaks to this. Both Romney and Obama are pretending that they can create something that they can’t. It is political rhetoric rather than economic reality.
Steven Kopits,
Your post was a masterpiece. Thanks.
Simon van Norden ,
Historically, products are replaced with more efficient one.
Eventually alternative energy production will drive down the price of oil.
The best policy is for production now, while prices are still high.
The argument against is to hedge on the possibility that we will never achieve alternate resources better than oil products. This anti-production policy, however, makes a loud signal that we do not believe in alternative energy sources in the medium-long term.
Pete,“Currently we pay for both the oil and the defense of its production and delivery to us.
There’s a little truth to that, but we don’t actually import much from there. We are defending the global supply level. Supply to our allies (e.g. Libya–>France).
its a fungible commodity. but also, of course there is an increased demand to build ribbons of highway, allowing folks to live even further from the workplace. DC is booming with highway construction jobs. This just increases the demand for gas. Should not have had “miles per gallon” rules, but simply “miles” rules. If folks had to pay by the mile instead of the gallon, they would live closer to their jobs.
If folks had to pay by the mile instead of the gallon, they would live closer to their jobs.
Comrade Pete, you would make a fine Politburo member.
However, I do like your earlier comment – Easiest solution is to stop subsidizing the oil companies with troops in the mideast.
The mideast is crumbling before our very eyes. Radicals are filling the power vacuum, and they know the power of oil.
The price of oil will rise for every country, but countries that rely on imported oil are going to experience a massive outflow of income and wealth.
We know the time required between prospecting and first oil. We have no clue as to the time it will take to make solar, wind, etc a feasible alternative. If there was ever a time to drill, it is now.
pete says: If folks had to pay by the mile instead of the gallon, they would live closer to their jobs.
“Folks” are already paying by the mile in the form of increasingly expensive small cars that get higher mpg while offering less room and utility.
Oh, you mean “pay the government” by the mile rather than “pay the oil companies” by the gallon. That will certainly solve the supply issue. That must fall under the principle that the falling tide lowers all ships.
The Canadian supply and pipelines also cost less due to transport costs.
This also addresses two major security issues. If the price of oil goes up, the cost of transporting goes up. Local supply saves this cost. It also gives us a sort of option and protects us military supply blocks abroad.
The argument for not extracting for security only makes sense if we still drill and build the infrastructure to get the oil where we need it. That infrastructure would also need to be maintained/tested, which probably mean that we would need to actually extract,, just doing it well below capacity.
Pete, the increased consumption and congestion in the DC are is due to the excessive money supply in the region.
What I meant is that mpg rules on cars combined with superhighways have kept gallons per person about the same. Last time I looked anyway.
FYI, a sampling of some per capita consumption numbers for 2011 (BP total liquids for consumption, Wikipedia data for population):
US: 22 BO per person/year, trending down
Japan: 12.7 BO per person/year, trending down
China: 2.7 BO per person/year, trending up
As previously noted, at the 2005 to 2011 rate of decline in the ratio of Global Net Exports of oil (GNE*) to Chindia’s Net Imports (CNI), the GNE/CNI ratio would approach 1.0 in 18 years, when Chindia’s combined net imports would theoretically equal 1.0, thus consuming 100% of Global Net Exports of oil.
While we all agree that won’t happen, the fact remains that the rate of decline in the GNE/CNI ratio has accelerated in recent years, falling from 11.0 in 2002 to 5.3 in 2011.
In my opinion, the dominant post-2005 pattern that we have seen is that net oil importing OECD countries are gradually being priced out of the global market for exported oil, as the developing countries, led by China, (so far at least) consume an increasing share of a declining volume of GNE.
*Top 33 net exporters in 2005, BP + Minor EIA data
Steven Kopits:
Your claims about the benign nature of Marcellus waste don’t hold water. Which is unfortunate, because we need all the radioactive brine storage containers we can get our hands on!!
Pennsylvania is dealing with all sorts of horrendous problems with frac’ing waste in public water supplies.
Read more: http://www.post-gazette.com/stories/news/environment/bromide-a-concern-in-drilling-wastewater-212188/#ixzz2AAfrqt8O
http://www.propublica.org/article/is-the-marcellus-shale-too-hot-to-handle-1109
Dumping by any other name would smell as sweet.
Now, what happens to those substances which are removed from ‘treated’ wastewater — the hundreds of tons of radioactive sediment that is carried in the flowback of each frac’d well? Dumped where?
Fascinating.
Professor Hamilton does not support increased excise taxes on fuel. Only one post mentions a ‘carbon tax’. the word ‘tax’ is otherwise absent from this blog thread.
Should I interpret broad-based support for a cheap energy policy?