Recent data is very encouraging concerning the oil import picture. Net imports - which were over 12 million barrels a day during much of the last decade - have dropped to below 7 million barrels a day. At the same time, daily imports from Canada have actually increased from about 2.5 million barrels in 2007 to nearly 3 million last year. The net result has been a decline in non-Canadian imports from 9.5 million barrels a day to 4.5 million barrels a day. While these numbers are encouraging, we are still economically and strategically exposed to the risk of an "oil shock." I strongly believe that we should work hard to get non-Canadian imports down to the 1 million barrel a day level.
A recent article on this website pointed out that virtually every recession since the Second World War has been preceded by a run up in oil prices. While it escaped the notice of many "pundits," the same was true of the Crash of 2008. Indeed, the price run up combined with the dependence of the United States economy on imported petroleum was, in many ways, as unprecedented as the Crash itself.
The price action was devastating. Starting in January 2007 and ending in July 2008, the price run up (using Brent spot prices) took prices from $53.68 a barrel to $132.72 a barrel or an increase of $80.04 a barrel. Aficionados of oil pricing may quibble and suggest that refiner acquisition cost or landed crude prices are better metrics but they all take you to the same place. Prices more than doubled, indeed nearly tripled, in a year and a half. The price trend "played through" the nasty Bear Stearns debacle as if it never happened. Then - finally - in August 2008, the roof fell in on the economy, the market and, soon thereafter, oil demand.
Let's look at what really happened. 12 million barrels (a rough estimate of daily imports during the run up) times an $80 a barrel increase is $960 million a day - when I was growing up in the 1950s, this was considered a lot of money. On an annual basis, it is roughly $350 billion or nearly 3 percent of GDP. That's 3 percent of GDP taken out of the pockets of American consumers and businesses so that it is not available to be spent elsewhere. $350 billion going overseas and into sovereign wealth funds and/or Swiss bank accounts (depending upon the integrity of the oil producing country) and only slowly being recycled into the U.S. economy. The table below provides monthly Brent prices and presumed total US oil import bill (in billions of dollars) on an annualized basis at the monthly price. Data is from the Department of Energy, Energy Information Administration.
|Price Per Barrel||$53.68||$67.49||$73.23||$82.34||$92.18||$109.07||$132.72|
|Annual Import Bill||$235.12||$295.61||$320.75||$360.65||$403.75||$477.73||$581.31|
By July 2008, the annualized outflow was in excess of 4 percent of GDP and the economy could not take it any more. This created an enormous outflow of cash from American businesses and consumers and reduced demand for domestically produced goods and services. At the very same time, the oil price increase fueled inflation so that monetary policies normally employed to mitigate recession become risky. We were in the worst of all worlds - less money spent on domestic consumption leading to an economic slowdown and inflationary trends exacerbated just as businesses are bracing for lower demand.
I am not saying that the run up in oil prices was the sole cause of the Crash, but I do believe that it made the Recession deeper and more damaging because it sucked so much money out of the hands of U.S. consumers and businesses. I am sure there were homeowners drove over the brink to default by higher gasoline prices and there certainly were small businesses devastated by the reduced demand caused by consumer distress due to high gasoline prices.
The carnage to the U.S. economy was worse than in the past because of shifts in the usage of petroleum. In the past, considerable amounts of petroleum were used by electric utilities, by residential and commercial space heating customers and as boiler fuel by industrial customers who could switch to natural gas when oil prices skyrocketed. By 2007, everyone who could switch had already switched and we had replaced a chunk of electric utility and other demand with increased transportation sector demand. The table below provides demand in millions of barrels per day in 2007 as well as in 1980 and 1990 (two previous periods of "oil shock") respectively consumed by the electric utility sector, for commercial and residential space heating and for transportation. Data is from the Department of Energy, Energy Information Administration.
|Comm. and Resid.||1.516||1.231||1.045|
Transportation sector demand is relatively inelastic because there is really no easy fuel switching option. Thus, prices can move dramatically higher due to very limited short term demand elasticity. Our only real strategy for reducing demand has been to have a recession, create unemployment and reduce the consumption of gasoline because fewer people are driving to work. In 2008-09 we did a really good job of reducing demand by increasing unemployment but the cost to our economy and our society has been prohibitive.
Fortunately, we have gotten very lucky. Domestic production is way up and consumption is being brought under control due to vehicle mileage standards, demand response to higher prices and promising new technologies. While short term price elasticity is limited, in the intermediate and long term there is substantial ability to shift the vehicle fleet in the direction of better efficiency. In May 2008, as prices were skyrocketing, I bought a Prius for my daughter and discovered that new cars weren't available and a six-month old used Prius was selling at the list price for new cars. Hybrids are here to stay and finally offer consumers an acceptable way to achieve substantially better mileage.
We simply can't let this happen again. We should follow an "all of the above" strategy aimed at reducing non-Canadian imports to 1 million barrels a day. While a run up in world oil prices would drive up prices here as well, the money would have a much greater tendency to be recycled into the U.S. economy. Canada is closely enough integrated into our economy that increasing dollars going across the border should not be a big problem. The U.S. dollar would adjust downward against the loonie, Canadians would buy more condos in Florida, and take more shopping trips to Maine, and all would be well. While prices would still go up in the event of a world oil "shock," more of the money would stay at home. The increased dollars going to U.S. producers would turn into bigger royalty checks, tax receipts, shareholder dividends, and bonuses. With a larger domestic production industry higher prices and increased revenue would produce more investment in exploration and production.
We should redouble efforts to reduce consumption by imposing taxes on gasoline and diesel fuel. We should strictly enforce vehicle mileage standards. We should pursue the conversion of remaining residential and commercial oil space heating customers to either natural gas or geothermal heating. To the extent that there are "institutional" barriers to such conversions, it should be a national priority to surmount them. We should encourage widespread conversion to CNG and LNG transportation usage with tax credits, vehicle standards and government RFPs favoring compressed natural gas (CNG) and liquefied natural gas (LNG). We should enact the Open Fuel Standard Act which would facilitate the mixing of methanol into the transportation fuel supply and the Natural Gas Bill which would encourage the use of CNG and LNG in transportation. We should encourage the domestic production industry to continue its successful efforts to increase domestic production and clear away barriers to necessary infrastructure investment.
We could return to runaway oil price increases at any time. There are ominous signs that the Middle East may well be on the verge of a Sunni/Shiite shootout that could make past conflicts look like touch football games. This would create havoc in world oil markets and drive prices higher. At the same time, oil demand is growing in emerging markets and within OPEC countries themselves. We should be using this opportunity to brace ourselves for some potentially nasty developments in the oil market. We must take steps to reduce the macroeconomic fallout from this kind of event.
We will either move in the direction of substitution of natural gas for petroleum in the transportation sector or we will be moved in that direction by events and market forces out of our control. If we fail to make the transition before the next oil shock, we will have another macroeconomic event and the impetus for change will be even stronger.
From an investment perspective, Methanex (NASDAQ:MEOH) is now planning at least one methanol plant in the United States. The methanol market will be strong without a new source of demand in the United States and would really take off if we adopted methanol blending. Clean Energy Fuels (NASDAQ:CLNE) has a dominant position in LNG for long distance trucking and is the leader in the CNG for fleet vehicles market; it will ride the wave of natural gas transportation to higher levels. Chesapeake Energy (NYSE:CHK) is a leading natural gas producer well positioned to prosper in a stronger market.