Domestic Energy

Posted on October 26, 2012 by David Laidlaw

While most recent economic news is negative, there are longterm trends in place that are very positive. Foremost among these positive trends is the increasing supply of domestically produced oil and natural gas. 

 A Wall Street Journal article published on 6/27/2012 highlighted a report by the US Energy Information Administration that predicted that one-half of all oil consumed in the US will be domestically produced by 2020 and 82% will come from the Americas (primarily Canada and South America). OPEC also estimates that it will sell very little oil to the US by 2035.

 The Americas accounted for 48% of global production investment in 2011, up from 39% in 2003. This increased investment has already led to significant production gains. US production has increased 6% from October 2011 to March 2012.

 The reason for these production gains is technological.  Hydraulic fracturing (fracking) allows oil and gas to be extracted from rock formations that previously were too difficult to exploit.  Oil sands in Canada, which represent some of the largest oil reserves in the world, become economically viable to exploit when prices are above $70-80 per barrel. Finally, underwater drilling technology continues to improve in the Gulf of Mexico and off Brazil’s coast.

The shift to domestic production has two primary benefits and a third contingent benefit. More domestic supply translates into less expensive oil and gas. These decreased prices benefit the US consumer who has to allocate less of his or her budget to direct (e.g. filling up the gas tank) and indirect (e.g. shipping costs) energy costs. Lower energy prices then lead to increased consumption of other items and faster economic growth. The International Monetary Fund has estimated that a $10 per barrel increase in the price of oil causes a decrease in GDP of 0.5%.  Decreasing oil prices will help GDP, but we do not know the degree of the economic growth that will result.  

The second benefit of more plentiful domestic supplies of energy is the boost to the manufacturing industry. Over the past decades, US employment within the manufacturing sector has contracted as domestic wages increased relative to foreign competition. However, lower US energy costs relative to foreign markets such as China level the playing field so that certain manufacturing processes can be carried out more economically in the US than abroad, even given the higher wages earned by US employees. For example, a story in the Cleveland Plain Dealer reported that Federal Reserve member Sandra Pianalto learned from a steel manufacturer that US energy costs were 1/3 those of a simiar European plant. Over the past couple of years, manufacturing employment has increased about 5% in the US while wages have inched up from $23 to $24 per hour. While employment and wages have risen incrementally, productivity has increased a robust 3.4% per year since 1987 according to a Bureau of Labor and Statistics report.

Finally, energy independence may reduce our defense expenditures which disproportionately flow to the Mid-East. If we are not dependent on petroleum products from this region, we may be less likely to expend our resources protecting foreign supplies and shipping lanes. This benefit is much more speculative, but could reduce defense spending over the long-term.  

Growing production and greater energy efficiency suggests that these trends will continue for decades to come. The above benefits will flow to the US economy regardless of whether or not the country becomes energy independent.