Oil Quotas and Import Fees? No, Get America Back to Work
America’s economy is a massive beast. With just 4.3% of the global population, the U.S. produced 25% of the world’s GDP in 2019. As Mark Perry, a scholar at the American Enterprise Institute, points out, four America’s states combined (California, Texas, New York and Florida) each produced more than $1 trillion in output and together as a separate country would have ranked as the world’s third-largest economy.
It comes then as no surprise that if you undertake a policy to lockdown the American consumer and drastically curtail economic activity, whatever the merits, there are going to be catastrophic economic and employment losses. These losses are showing up in a spike in unemployment, a massive reduction in the nation’s wealth holdings, and diminished expectations on future prosperity.
As in many sectors of the U.S. economy, the lockdown has not spared the American oil patch, which for many companies is now turning into an existential crisis. Recall that in 2019, the U.S. was the world’s largest oil and gas producer and a net exporter of petroleum to the world market. The surge in U.S. oil production in recent years came almost entirely from the use of an innovative extraction technique called hydraulic fracturing (fracking) that permitted access to vast domestic resources deemed uneconomic in the past.
Stay-at-home orders and related restrictions for controlling the COVID-19 virus have been accompanied by a not so unexpected massive decline in petroleum demand. World petroleum use is likely to fall by close to 25 million barrels/day (MMB/D) in April 2020, about 25 percent of world consumption. For the U.S. alone, we can expect to see a decline of anywhere between 5-7 MMB/D by the end of the month, around 30 percent.
This demand destruction is taking place at the same time as the Russians and Saudis are adding (or threatening to add) 3-4 MMB/D of additional supply to take market share from each other and U.S. shale producers. World oil prices have fallen from $60/b in January to $20/b over the last 30 days. But these are the prices for so-called marker crudes. Regional prices in some parts of the U.S. are in the single digits, as is the case in Canada and Mexico. We can expect a wave of bankruptcies from oil producers perhaps even among some large independents if very low prices remain throughout 2020.
On Friday, a virtual meeting of the G20 energy working group is scheduled to address, among other agenda items, the Saudi-Russia price war and related proposals to work with OPEC to curtail U.S. production. The President has also announced that he is entertaining other initiatives ranging from imposing a crude oil import fee or quotas to lift domestic oil prices by constraining the importation of crude oil and petroleum products into the U.S. An end to the Saudi-Russia price war would be helpful and likely lift prices somewhat, but sustaining production cuts among an even well-disciplined cartel is nearly impossible, and OPEC + Russia is a long way from a disciplined cartel.
The President has been asked to intervene in this price war to convince the parties to reach an agreement and some U.S. producers are calling for mandated production cuts as a way for the U.S. to cooperate with OPEC. But calling for an expansion of OPEC+ to include the U.S. is not likely to be effective or a particularly good idea. The problem is that the world economy has nearly ground to a halt and consumer and industrial demand has cratered and none of these proposals are a remedy for that particular problem.
We’re not against fig leaves, and our estimates show a reduction in annual oil output of at least 0.5 MMB/D in 2020 and perhaps over 1 MMB/D in 2021. These are in line with the latest estimates from the U.S. Energy Information Administration. If production cuts are raised at the G20 meeting on Friday, Secretary of Energy Dan Brouillette can legitimately point out that he gave at the office.
Also, anyone calling for an import fee or quota needs to check their math. One of the problems of being a net exporter of petroleum is that tariffs are not likely to raise oil prices. In fact, it is likely to push them further down. The oil industry pushed hard for years to lift the ban on oil exports and succeeded in getting legislation to do so in 2015. By this date, constraints on oil exports were imposing large transportation and refining inefficiencies on the domestic petroleum industry.
The U.S. is a large country and so minimizing transportation costs for moving crude oil to market are important. Oil prices are set in the world market so a refiner in Hawaii would rather purchase crude from Indonesia than Houston and save on transportation costs. A Gulf coast refiner whose processing technology is tuned to heavy crude might find it cheaper to use Mexican or Canadian oil than one with alternative specifications produced in North Dakota.
Lifting the ban on crude exports allowed the entire North American production platform to minimize transportation and processing costs and lifted crude prices throughout the domestic oil patch. Remember the Keystone XL pipeline from Canada, it is finally under construction and remains one of several critical pieces of an efficient transportation solution for North American petroleum. U.S. refiners have open access to the Mexican market and move millions of barrels of gasoline and diesel into that market every day.
Open access to markets and crude and product transportation efficiencies permit U.S. refineries to operate at high levels of capacity utilization. The free movement of capital, crude oil and petroleum products remain critical to sustaining the productive capacity of the U.S. oil and natural gas industry. These efficiencies played a large role in the rapid expansion of U.S. oil production and remain one of the central reasons that large volumes of U.S. crude imports also result in large volumes of higher value added exports of petroleum products. We disrupt these flows at our own peril.
OK, what about joining in with OPEC and cutting U.S. production? As appealing as this might sound to some in the industry, it’s a very bad idea. First, it is not likely to work since there is no national program for undertaking such measures and second, where permitted among some state authorities, it will introduce (or in some cases reintroduce) more government control over U.S. oil production. It might sound like a good idea now, but in a few years when environmental activists have more control of the regulatory agenda, those calling for such measures might find the outcome more than unpleasant.
Instead, the President should use this opportunity to rapidly advance his current program of common sense deregulation and other long-term policies that will allow capital to flow back into the industry when market conditions merit. Some near term financial support for the companies might make sense and we would support purchases for the Strategic Petroleum Reserve since it could be expanded at fire sale prices and remains an important strategic asset.
In the end, the crisis in both the American oil patch and the national economy require more of us to get back to work. The answer to this crisis is to give the American people a concrete plan on restarting the national economy. We are both more than long in the tooth and one of us has a severely impaired immune system. But the costs of the broad economic shutdown are now becoming intolerable to a broad range of the American workforce and offer considerable potential to impose long-term damage on the American economy. Many sound proposals have come forth which can protect the most vulnerable and let most of us get back to work. Pick one.
Lucian Pugliaresi is the president of the Energy Policy Research Foundation, Inc. (EPRINC) in Washington, DC. He served on the National Security Council staff during the Reagan Administration. Larry Goldstein is the former president of EPRINC and a co-founder of Petroleum Industry Research Associates in New York City.