Don’t Fear an Oil Bust

Yes, it’ll hurt the U.S. energy industry. It could also make it better.

A vehicle drives past workers near power plant number 10 at Saudi Electricity Company's Central Operation Area, south of Riyadh, April 27, 2012.
Workers chat at the Consol Energy Horizontal Gas Drilling Rig, which is exploring the Marcellus Shale, outside Waynesburg, Pennsylvania, on April 13, 2012.

Photo by Mladen Antonov/AFP/Getty Images

America’s oil boom might be about to die down for a bit.

The U.S. drilling revival, which has seen daily oil production grow roughly 60 percent since mid-2011, was fueled by high crude prices that made profitable the expensive process of extracting oil trapped in shale and other rock deposits. But the days of $100 hydrocarbons are over for now. With the world momentarily pumping more oil than it can use, the cost of a barrel has swan-dived below $70. OPEC could have cut its own production in order to ease the glut, but recently chose not to amid talk that Saudi Arabia is waging a “price war” designed to protect its own market share by putting the oil men of North Dakota and Texas out of business.

Nobody knows exactly how far prices can fall before most shale oil, which may account for up to 55 percent of U.S. production, becomes unprofitable. The process of fracking through rock and using horizontal drilling to retrieve crude is costly—much more so than conventional drilling—but thanks to improved techniques, some believe that new wells can make a return at prices as low as $25 a barrel. That’s led analysts to argue that production will keep on growing, no matter what OPEC does.

But already, there are signs that the drop is taking a toll. On Tuesday, Reuters reported that the number of new well permits issued in the U.S. tumbled 40 percent last month. If that slide continues as low prices makes oil exploration unprofitable, it could mean that America will soon be pumping a bit less crude. (Because shale wells don’t last very long, companies need to constantly drill new ones to keep production up.)

That would be unpleasant news for states that thrive off the oil industry or workers who have flocked to it (especially if they’ve been crowding into grungy boomtowns with Manhattan-priced apartments and a shortage of women just to get a piece of the action). But if a bust really is upon us, that might not be such a bad thing for the country as a whole, or even the long-term health of the oil business.

Low oil prices, after all, have lots of benefits. Most obviously: low gas prices, which are now averaging less than $3 a gallon in most of the country and trending down. According to a Goldman Sachs analysis reported in the Wall Street Journal, the decline of gas prices has already amounted to a roughly $75 billion tax cut for consumers. And as Matt O’Brien writes at the Washington Post, cheap fuel should also ease concerns about inflation, taking pressure off the Federal Reserve to raise interest rates and cool down our already tepid economy. (Central bankers aren’t really supposed to pay attention to the price of oil anyway, but as O’Brien explains, in reality they do.)

You might be wondering: Won’t the economy suffer a bit if companies drill and sell less oil? Well, yes, if oil production tails off, it’ll take a small bite out of GDP. But that should be more than balanced out as consumers spend the money they save filling up their cars. As a rule, a dollar in a family’s bank account is more valuable to the economy than a dollar in an oil company’s bank account, because it’s more likely to be spent quickly and less likely to end up going to a foreign investor. On balance, cheaper oil probably means slightly faster growth for the U.S. economy.

A period of low prices could also help transform the U.S. drilling industry for the better, Michelle Foss, chief energy economist at the University of Texas at Austin’s Bureau of Economic Geology, tells me. Right now, the band of small and midsized oil companies that have fracked their way to riches aren’t the most efficient or strategic bunch. As one executive put it in 2010, the early days of the boom were mostly driven by “brute force and ignorance” as drillers tried to get crude out of the ground as fast as possible. That approach has led to lots of poorly structured wells that quickly run dry on oil and wasted effort fracking shale deposits that don’t produce much to begin with. When prices for oil were lofty, the industry could afford to be that sloppy. With prices sinking, however, it will be forced to improve its methods. That could be good for the environment. Fracking involves pumping a toxic mix of water, chemicals, and sand into shale deposits to crack them, and the more sparingly it’s used, the fewer problems it creates. A more cautious industry could also be good for investors, who would see less of their money sunk into failed wells.

“I don’t mind [low price] cycles,” Foss says. “I think cycles are actually kind of good for cleaning things out, strengthening the best performers, causing the poorest ones to find something else to do for a living, and revealing what it takes to operate in this business.”

That’s important, because the low prices we’re seeing now probably won’t last forever. If production in the U.S. flattens out or declines, that should naturally push the cost of a barrel back higher. We should also expect prices to rise once Europe shakes off its current economic troubles, or if China’s growth picks up again. And there’s always the chance of a big conflagration in the Middle East that will send the market surging. But whatever causes it, we should expect prices to eventually rise again, and when they do, drilling in the U.S. will probably pick back up.

Not that we’ll necessarily see a repeat of the boom we’ve just witnessed. “Let’s say oil prices stay down for a couple years, then rise back to $100,” James Hamilton, an economist and leading oil expert at the University of California–San Diego, says. “I think we’d see oil production pick up again, but not quite at the same pace we’ve seen over the last few years.” Why slower? Investors might be a little more cautious in the wake of a bust.

But again, that’s such not a terrible thing, if it means money goes to the smarter, more efficient drillers who learn how to survive in an era of low prices. This round of the shale boom might be nearing its close. But the oil will still be there if we need it.