There is an emerging narrative in some parts of the public discourse that the recent spike in oil prices has nothing to do with President Biden cancelling the Keystone Pipeline. The talking points apparently being distributed is that it is all attributable to “supply and demand”. We are also being told that we have always exported and imported oil, and nothing in particular has changed since the Biden administration came into office.
Is there any truth to these talking points? Let’s find out.
In Figure 1 the green function reports millions of barrels of oil being produced every month in the United States. The black function reports the price of crude oil (West Texas Intermediate), also on a monthly basis:
There does not seem to be any correlation between crude-oil prices and production volumes, does it? To make sure, let’s take a more formal look. We calculate the percent changes in price and quantity and let Figure 2 report the 426 resulting pairs of data in order from the largest price increase to largest decrease, and the correlating change in quantity:
Based on the resulting trend lines we could calculate formal correlation values, but there is really no point. The plain and simple conclusion from Figure 2 is that there is no correlation between changes in crude-oil prices and the quantity of oil produced.
It is worth noting that Figure 2 reports short-term observations; it is entirely possible that a sustained higher level of prices will motivate a higher level of production. However, such a correlation is difficult to produce without data “clustering” (one set of observations from one period of time vs. one set for the other variable from another time), a technique that easily puts an unhealthy amount of distance between us and reality. Therefore, I will gladly leave it to others to look for longer-term correlations between oil production and price levels.
Given that we accept the limited price-quantity correlation, there is a reasonable explanation to the almost U-shaped production trend in Figure 1. To begin with, we are comparing crude-oil prices to production, not total consumption. As Figure 3 explains, the downward trend in domestic production from the mid-’80s to the turn of the Millennium could be explained not by a decline in oil demand, but by a substitution of imported oil for domestic oil. Going back to 1991, Figure 3 reports the U.S. trade deficit/surplus in petroleum product quantities, i.e., a net-barrels balance:
Assuming that the downward trend – growing net imports of petroleum products – stretches back to at least the mid-’80s, we see more clearly why there was no apparent correlation between the crude-oil price and domestic oil production.
The trends in prices, production and trade balance change after 9/11. Domestic production flattens at first, then starts to rise again. As this happens, the trade deficit begins to shrink.
This turn-around correlates with sharp increases in crude-oil prices, making it reasonable – all other things equal – to suggest that the rise in prices is the cause. However, that part about “all other things equal” is essential: the rise in crude prices began already in the late ’90s, without a reaction in oil trade and production volumes. Furthermore, the price had to go from $40 per barrel to approximately $75 before there was a clearly visible change for the better in domestic oil production.
From about 2005 to 2015 we saw significant volatility in crude-oil prices. It is well known that price volatility leads to lower production volumes, as sellers are weary of getting their product out at a price that pays production costs. The oil markets have sophisticated price-insurance products to mitigate such swings, but those products – term and options contracts – can only mitigate, not eliminate, price volatility. In other words, they govern but do not alter price trends.
That said, there is a sustained period of high oil prices from 2010 to 2015 that likely plays a role in the steady rise in domestic production. The reason why it would have a stronger effect on production than prices had previously, is that it motivated a shift in production technology: this is the period of time when fracking made inroads and opened up new oil reserves.
Toward the end of the Obama presidency, the upward trend in domestic oil production is disrupted. By this time the fracking technology has reached the industry and is established, making it unlikely that the trend shift is caused by the drop in prices. Once a production technology is established, its operating costs are almost always minor compared to the fixed-cost investment in its establishment. Therefore, the price drop should not have had a direct effect on domestic production.
A more likely explanation is an increased regulatory presence from the federal government and a ramp-up in advocacy group activity to vilify fracking. This explanation is reinforced by the price-production trends during the Trump presidency: while the crude price fluctuates violently, oil production rises sharply and steadily all the way to the 400 million monthly barrel production mark in early 2020.
Since the Trump administration worked hard to roll back regulations, it is likely that the rise in production on his watch was due more to deregulation than to any particular changes in crude-oil prices. However, it is difficult to quantify the impact of regulations to such a degree that it can be compared statistically to established variables, such as the oil price and the production volume.
It is interesting to note that according Figure 3, the American trade deficit in petroleum products is replaced with a trade surplus under Trump. This is directly the result of the sharp rise in oil production on his watch, but it is also indirectly the result of the more muted increase that took place during Obama’s second term.
Figures 1 and 3 suggest that the U.S. economy needs to produce about 400 million barrels per month to be independent of foreign oil. Since the break in the positive trend from the Trump presidency has happened under the current administration, it is likely that the current trend will continue: we are, in short, en route back to the days when we depended heavily on faraway countries to supply us with oil along vulnerable supply chains with multiple choke-point bottle necks.
I find it humorous to listen to people on the left who complain – sometimes rightly – that our military presence in the Middle East is driven by our oil dependency. Instead of helping us maintain our energy independence, those very same leftists are often quick to criticize and try to stop domestic oil production, thus making us even more dependent on that oil for which they say we go to war. Then they turn around and suggest we all drive electric cars, which make us more dependent on minerals extracted in some of the most conflict-ridden parts of the world: the Congo and Afghanistan come to mind.
As if our exploitation of child slave labor in Africa would be any more acceptable than our immoral wars to protect our unnecessary foreign oil-supply chains.
Nothing would contribute more to peace and prosperity in America and the world than for every country to become as energy independent as possible. We can easily make it happen – all it takes is political courage.