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Economic Insights

Rising domestic oil and gas production has held energy prices in check. But it could be a different story if Middle East supplies are severely disrupted.

For now, it looks as though fracking has saved the U.S. economy’s recovery.  Were it not for the impressive increase in North American oil and gas production, the current hostilities in Iraq would have driven up global oil prices to $130–140 a barrel,1 a level that could easily have stopped  the United States’ already inadequate economic recovery, driven Europe back deeper into recession, and slowed growth elsewhere in the world, if not thwarted it altogether.  This, however, is only the beginning.  If North American energy sources have quelled fears about shortages and kept down prices, Iraq’s troubles could become much worse.  They have as yet, however, had little effect on oil flows throughout the Persian Gulf.  Should they, North American production would not be able to fill the gap, the price of a barrel would rise, and those higher prices would have their ill effects on economies worldwide. 

It’s Not about Energy Independence
Contrary to much comment in the media, the relief from fracking in the United States has little to do with energy independence.  Perhaps this concept would have meaning if the United States were involved in a global war, as it was twice during the twentieth century.  But short of such an all-consuming conflagration, whether this country can produce enough for its own needs or not means less than how much it is adding to or drawing on the world’s precious supply of energy.  Oil’s price is set on a global market, and all players, however much they produce, pay the global prices.  Some years ago, for example, when North Sea oil made the United Kingdom a net oil exporter, people there still paid global price, and when there were disruptions of supplies from the Middle East, the United Kingdom paid the higher global price, as did all other countries.  

Rather than address questions of energy independence, what U.S. and Canadian oil production have done to blunt the immediate impact of this horrible situation is to make a significant difference in global supplies.  More specifically, they have more than offset declines in Mexican and the North Sea production.  Table 1 makes this relationship clear.  Flows from Norwegian, U.K., and Mexican sources fell by some 1.002 million barrels a day, from the beginning to the present recovery in 2009, while U.S. and Canadian production rose by 3.548 million barrels a day.  They constitute 81.2% of the entire 4.382 million-barrel a day increase in global supplies during this time.


Table 1. Oil Production in Recent Years, Selected Sources
(000s of barrels per day)

 

World

Persian Gulf

Russia

U.K.

Norway

Mexico

Canada

U.S.

2009

72,609

20,754

9,495

1,328

2,067

2,646

2,579

5,353

2010

74,378

21,589

9,694

1,233

1,869

2,621

2,741

5,471

2011

74,489

22,953

9,774

1,026

1,752

2,600

2,901

5,652

2012

75,868

23,214

9,922

888

1,607

2,593

3,108

6,484

2013

76,039

23,010

10,049

810

1,530

2,562

3,324

7,447

2014 (YTD)

76,981

23,465

10,147

869

1,627

2,543

3,492

8,018

Source: Energy Information Administration (EIA).


More Reliable Supplies, Plus Hope       
Perhaps even more significant in the current context than the straightforward impact on supply is the hope for more reliable energy sources engendered by this surge in North American production.  The basis for such hope is apparent in Table 2, which shows the percent of world production accounted for by each significant producer.  The Persian Gulf as an oil source actually has become slightly more important.  That hardly speaks to reliability.  But Canada has gained dramatically as a global supplier, while the United States has soared.  The headlines boast that this country is now a bigger producer than Saudi Arabia, but more significant is that it is now more than one-third the size, in terms of production, of the entire Persian Gulf region, which includes Saudi Arabia, Kuwaiti, Iraq, Iran, the United Arab Emirates, and lesser suppliers, such as Bahrain and Qatar.  These relative gains do show a shift in world production toward more reliable sources.  To be sure, the United Kingdom, Norway, and even Mexico were reliable as their importance has declined, but with the rise of Canada and the United States, the more reliable sources as a group have risen to more than one-fifth of the world’s supply and more than half the size of the Persian Gulf.  


Table 2. Percent Distribution of World Oil Production, Selected Sources

 

Persian Gulf

Russia

U.K.

Norway

Mexico

Canada

U.S.

2009

28.5%

13.2%

1.8%

2.8%

3.6%

3.6%

7.3%

2010

29.0

13.0

1.7

2.5

3.5

3.7

7.3

2011

30.8

13.1

1.4

2.4

3.5

3.9

7.6

2012

30.6

13.1

1.2

2.1

3.4

4.1

8.5

2013

30.2

13.2

0.7

2.0

3.4

4.4

9.8

2014(YTD)

30.5

13.2

0.7

2.1

3.3

4.5

10.4

Source: Energy Information Administration (EIA).             


There is something else that is moderating the price effect during this latest trouble in the Middle East.  Unlike past times of supply interruptions or threatened interruptions, market participants this time have reason to hope, even expect, not just an increase in future global supply but also a continued shift in the direction of more reliable sources.  The impressive growth of production in Canada (35%, between 2009 and the present) and the United States (nearly 50%) is a significant part of that expectation, especially since indicators point to continued growth at such remarkable paces.  By contrast, Persian Gulf output has increased only 13% during this time, largely because of the development of Iraqi oil after the last bout of fighting and modernization of some Saudi production facilities.  Neither of these, however, are likely to be repeated going forward.  Though that prospect suggests slower growth in global supplies than otherwise, it does suggest a decrease in the significance in this volatile and unreliable region.

Giving hope especially is that there is a greater such shift in prospect.  Because fracking enables drillers to extract oil and gas from shale, all the world’s shale deposits now offer promise, when only a few years ago they hardly factored into the global supply equation at all.  Some nations, such as France, resist the drilling, as do some individual states in the United States, but market participants account for the promise anyway, and do so on the assumption that an energy shortage would change such attitudes.  Meanwhile, Australia, which has no such reluctance about drilling, recently announced a huge shale find that, if preliminary reports are to be believed, could increase global oil and gas supplies by some 13%.  Coming years also should see production from Brazil’s large, conventional oil find in the South Atlantic and the promising exploration Exxon is now doing in the Russian Arctic.  Russia, to be sure, hardly counts as a reliable source (with its temperamental, nearly autocratic government), but the increased supply will come to market nevertheless.  Of course, these future sources are not available now, but oil prices, just like those in every financial and commodity market, reflect prospects and risks as much as basic current supply and demand, and these positive developments weigh in market calculations against the risk that turmoil in Iraq could cut off other supplies in the future.     

The Danger Cannot Be Easily Written Off   
Still, there is no mistaking the huge importance of Persian Gulf supplies.  If the turmoil there were suddenly to take those supplies, or a significant portion of them, off line, the world would be hard pressed to replace those sources, and prices would rise with all their ill effects.  What is more, the Persian Gulf itself is also a choke point of no small significance in oil transport.  If production is a significant 30.5% of world output, upwards of 35% of seagoing oil and gas transport passes through the Gulf and the narrow Strait of Hormuz at its head.  If Iran were to become further embroiled in Iraq’s problems, or otherwise come to a confrontation with Western powers, the strait would close and the world would find itself without any of this still crucial supply.  To be sure, the U.S. Navy has a major presence in the Gulf, and it claims that it could prevent any such closure of the strait.  But even if the navy could hold Iran’s forces at bay, the strait would close anyway, for the still significant threat to shipping would prompt insurers either to refuse to cover cargos in the Gulf or raise premiums to unsupportable levels.

For the time being, though, markets have stood up well in the situation.  Shipments continue even from Iraq—and certainly from Kuwaiti, Saudi Arabia, Iran, the Emirates, and other sources—and even as the rise of reliable sources outside the region disarms fears of any additional disruption.  But given the continued importance of Gulf oil supplies in general and of the Gulf as a shipping lane, an expansion of this turmoil still threatens to overwhelm the confidence built on Canadian and U.S. supplies, and to raise oil prices, and, accordingly, to impede economic growth in general.   

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