Wednesday, May 1, 2013

Energy Independence and Analysis

The revolution in production of unconventional oil and gas in the United States is no doubt an important development for the economy. But it also has been accompanied by a lack of analysis. Case in point, Sunday's NYTimes piece on the "Dark Side of Energy Independence."  The authors, editors at Foreign Affairs, argue that increased US production could lead to a 50% reduction in oil prices, and then analyze the effects of this on oil producers elsewhere.  They point out that:
lower energy prices will undermine the stability of the Persian Gulf monarchies, whose hefty oil revenues have allowed them to win their populations’ loyalties through patronage and a lack of taxation. These countries do not always share American values or help advance American interests, but anything that destabilizes them would create problems that Washington could not afford to ignore.        
What is amazing about their argument is that they never consider how oil producers will react to lower oil prices. They do not consider the impact of $50 per barrel oil on the profitability of unconventional producers. If prices fall in half which oil projects are likely to be cut back? Presumably those with the highest costs. 

Nor do they consider how OPEC producers might react to this increase in oil production from elsewhere. They could, cut back their production, as comments from Saudi oil minister, Ali Naimi, suggests. But if OPEC cuts back then why would prices fall in half? Alternatively, facing lower prices desperate countries might increase production causing a further fall in prices, as Michael Levi notes

But the key point to remember is that unconventional production of oil and gas is a response to high oil prices. As prices fall the projects that are cut back are those that have the highest marginal cost. Failing to consider this is an invitation to faulty analysis.

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