The Macroeconomic Implications Of America's Energy Renaissance

Includes: DDG, DIG, DUG, ERX, ERY, XLE
by: Philip Mause

It is no secret that oil and gas production in the United States has increased rapidly in the last few years. Natural gas production is up by more than 5 quadrillion BTUs (Quads) since 2007 and oil production has increased by more than 40%. Total energy consumption has leveled off due to tougher vehicle mileage standards and more efficient end use; thus, the main effect of the increased production has been a sharp decline in imports. One of the standard ways for a country to increase its GDP is by "import replacement" and that seems to be working for us.

At the outset, I should point out that another important trend has been at work. The United States has been steadily reducing its petroleum and total energy consumption as a percentage of GDP. Between 2007 and 2012, petroleum consumption per real dollar of GDP declined by roughly 8% and total energy consumption per real dollar of GDP declined by roughly 10%. This article will focus on the impact of increased production.

Taking petroleum first, the table below compares production and net imports in millions of barrels per day in 2007 and 2013 (the 2013 numbers are estimates based on projections from the available data from the first nine months of the year. The source for the data (and all other energy data in the article) is the Department of Energy, Energy Information Agency.

Domestic Production Net Imports
2007 6,860 12,036
2013(E) 9,964 6,438
Click to enlarge

Net imports have declined by more than an amount, which could be accounted for by the increase in domestic production. This is due to a variety of factors including a more efficient vehicle fleet and an apparent displacement of oil by natural gas in the electric utility, residential heating, and commercial heating sectors. There also has been a (so far) miniscule displacement of oil by natural gas directly and indirectly (through electricity) in the transportation sector. My back of the envelope calculations suggest that some 147 million barrels per year or roughly 400,000 barrels per day of petroleum were backed out by the use of natural gas instead in three sectors.

The increase in natural gas production has had two major effects: net natural gas imports have decreased markedly and natural gas has displaced a good deal of coal consumption in the electric utility sector. The table below provides natural gas production (dry gas) and net imports in billions of cubic feet (BCF) for 2007 and 2013.

NG Production Net NG Imports
2007 19.266 3.785
2013(E) 24.300 1.100
Click to enlarge

We are still a net importer of natural gas but the import levels have been reduced by some 70 per cent. We will probably always import some natural gas because of the geographical advantages of some Canadian supply sources to our demand centers but we could become a zero net importer if exports increase due to planned LNG export projects. Readers should also be aware that there has been a sharp uptick in the production of natural gas liquids; the increase has been from 1.783 million barrels per day in 2007 to 2.525 million barrels per day estimated for 2013.

Looking at the electric utility sector, the table below provides the millions of kilowatt hours generated by coal, natural gas, petroleum, and wind in 2007 and 2013.

Coal Natural Gas Petroleum Wind
2007 2,106,456 896,590 65,739 34,450
2013(E) 1,614,000 1,115,000 27,000 160,000
Click to enlarge

The displacement of coal by natural gas and wind in the electric utility sector (which is where more than 90% of coal is used) has been a factor leading to a sharp increase in net exports of coal, which have gone from 23 million tons in 2007 to an estimated 117 million tons in 2013.

We have gone through a lot of numbers and used some different metrics but summing up we have had at least the following impacts: 1. increased oil production has reduced net oil imports; 2. increased natural gas production has reduced net natural gas imports; 3. increased natural gas and wind production has displaced both petroleum and coal in the electric utility sector probably leading to an increase in net coal exports; and 4. increased natural gas, natural gas liquid and wind production has displaced some petroleum in the electric utility, residential heating and commercial heating sectors.

The increased net coal exports of 94 million tons (assuming a price of $50 per ton) should generate $4.7 billion per year. The reduced net natural gas imports of 2.685 BCF (assuming a price of $4 per MCF) should generate $10.74 billion per year. The big money is in the reduced net oil imports. I am not going to credit the entire amount of lower net oil imports to increased domestic production. I am going to credit domestic production for the full amount of domestic production increase (3.104 million barrels per day), the estimated amount of natural gas displacement of petroleum (400,000 barrels per day) and the full amount of the increase in natural gas liquids production (742,000 barrels per day); this totals 4,246,000 barrels of reduced net imports of petroleum per day. Using 1.55 billion barrels per year at $90 per barrel, we get a roughly $140 billion per year decrease in America's oil import bill. Adding this number to the values of the reduced net natural gas imports and the increased coal exports, the total net trade benefit comes to roughly $156 billion per year. This number is a bit less than 1% of GDP and represents a very significant part of total GDP growth since 2007.

It is interesting that our net trade deficit has gone from $699 billion in 2007 to an estimated $478 billion in 2013, a decline of $221 billion. This is a bit more than the total decline in oil imports (5.562 million barrels per day or $183 billion) plus the decline in net natural gas imports ($11 billion) and the increase in coal exports ($4.7 billion). Admittedly, some of the decline in petroleum imports is due to reduced consumption rather than increased domestic production.

I am not a mercantilist nor do I believe that we should make a fetish out of import replacement. I would not want to have to figure how to grow bananas in my garage and I would hate to lose European cheese. On the other hand, we tend to measure the economy's success in terms of GDP growth. If domestic demand stays exactly the same and domestic production somehow manages to replace a certain volume of imports, GDP increases in an amount roughly equal to the value of the domestic production.

The good news is that America's Energy Renaissance has added nearly 1 per cent of badly needed GDP growth to the domestic economy (the number is probably higher because of the construction of supporting infrastructure, which will be used over a number of years). Now for the bad news. Even with this tailwind, our anemic economy has just barely managed to limp along constantly on the verge of slipping back into decline. Indeed, it is a bit frightening to think about where we would be if we hadn't had the good fortune to experience such growth in energy production.

Another important effect may be that the United States should be somewhat less vulnerable to an oil shock. A rapid increase in world oil prices would still have an impact in that, in the absence of price regulation, prices in the United States would rise to the world price level. However, much more of that money would stay in the United States increasing the income of royalty holders, energy companies and investors. In addition, the industry is much better set up to respond to a price increase by rapidly ramping up drilling activity and production. These positive effects would, at least to a significant effect, offset the negative effects of price increases on consumers.

To the degree that the trend toward reduced net imports persists, there may be a tendency for the dollar to strengthen against other currencies. This, together with economic performance, which seems extraordinarily weak in light of the strong "tail wind" provided by increased domestic energy production, underlines the case for continued expansive monetary policy.

We can still reap the benefits of the increasing production of natural gas and petroleum by reducing imports. In the case of petroleum, we have a long way to go before becoming a net exporter. In the case of natural gas, we may be running out of opportunities to reduce imports. Instead, the future may increasingly depend upon utilizing natural gas to displace petroleum in the transportation sector and/or exporting gas in the form of LNG.

A lot will depend upon sensible policy responses. If we get to the point of becoming self-sufficient or even become a net exporter, there will be a temptation to subsidize domestic consumption (the results of which can be observed in Venezuela). We should resist these temptations and rely on market forces to allocate supply efficiently and to create incentives for new production. The energy sector can be the key to embarking on the path to dynamic economic growth. I am still very hopeful that we will find that path soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.