Dark side of the boom: Diving oil prices could curb U.S. production

The Kansas City Star

Kenneth White has spent 30 years in the oil business, and as owner of White Exploration Inc. in Wichita he’s more than a casual observer of the recent 25 percent drop in oil prices.

Any decision to drill for more oil is tied to its price, and although he’s not cutting back yet, the question looms for White and the rest of the country’s oil industry.

If prices “continue to go down or stay down, you’ll see a bit of a slowdown,” he said.

The plight of oil producers probably won’t elicit much sympathy from motorists who are enjoying the lowest gasoline prices in four years. Prices in Kansas and Missouri have fallen below $3 a gallon, down 33 cents in just the last month. Average households, if prices stay down, will save $500 or more annually at the pump.

That benefits the overall U.S. economy, and retailers should see a brighter holiday season with the extra cash in consumers’ pockets.

But it’s not all good news when it comes to lower oil prices, with potential problems or challenges that go beyond the financial outlook for oil companies

State economies that have benefited the most from the country’s rebound in oil production, such as Texas and North Dakota, are vulnerable to an economic slowdown. North Dakota, with its high oil-production costs, could be among the first to feel the impact. A state official recently said the state should prepare for a downturn.

Kansas, with a more diversified economy and a smaller oil industry, would be less affected and, overall, even helped by falling oil prices. Missouri’s economy, which doesn’t have an oil industry, is a clear winner when energy prices fall.

Businesses that have counted on high oil prices have their own issues. Electric vehicles, for example, could be a tougher sell, with their economics not as attractive in the face of cheap gasoline or diesel .

The possibility that fuel efficiency loses its luster faces Ford Motor Co., which has spent billions of dollars to design and build an aluminum F-150 pickup at its Claycomo plant. The vehicle will be lighter and more fuel efficient, but when it rolls out in December will potential customers find those traits so compelling?

Finally, there is the effect of lower oil prices on the country’s drive to energy independence.

Net imports of oil and petroleum products have fallen to their lowest in 29 years as U.S. oil production surged and consumption softened. The effect of lower oil prices on production and demand could be a setback.

“We could see a reversal and increase our import dependence,” said Stephen Brown, an economist and former official with the Federal Reserve Bank in Dallas.

Oil prices began their decline in June, when a barrel of West Texas Intermediate oil, the U.S. benchmark, was over $100. By last week it was hovering at $80 — which is exactly where oil futures closed Monday. That’s enough to reduce gasoline prices by roughly 60 cents a gallon.

The Energy Information Administration predicted that gas prices would fall because of ample oil supplies and lackluster demand. But it’s hesitating to sketch out how that could affect domestic oil production as it weighs how long the lower prices will hang around. It’s not unusual for oil and gas prices to drop at the end of a year.

The federal agency said U.S. oil production reached 8.7 million barrels per day in September, the highest monthly production since July 1986. For now the agency is sticking with a forecast that calls for production to average 9.5 million barrels per day next year, the most since 1970.

“It’s premature to reset our forecasts at this point,” said Tancred Lidderdale, an analyst for the Energy Information Administration.

In fact, there is uncertainty about what is going to happen.

James Williams, an analyst for WTRG Economics, said a big unknown is Saudi Arabia’s intentions, which may emerge at a meeting of the Organization of the Petroleum Exporting Countries in late November.

Some OPEC members such as Iran are arguing for production cutbacks to try to raise prices. But Saudi Arabia may want to keep production unchanged to build market share by keeping prices low and pushing some U.S. producers out of the business. A similar strategy by the world’s largest oil producer in the 1980s and 1990s killed what had been a successful U.S. effort to reduce oil imports.

“If Saudi Arabia does that again, it means we will have lower prices for at least another year or two,” said Williams.

The surge in U.S oil production — it has increased 50 percent since 2008 — is mostly from the fracturing of underground shale formations. That means it has high production costs, which didn’t matter when oil prices were rising.

But the vulnerability is now emerging.

A recent report by Sanford C. Bernstein & Co., a New York research and brokerage firm, said oil at $80 a barrel makes one-third of U.S. shale oil production uneconomical.

This U.S energy boom is also more indebted to outside investors, who are showing signs of getting nervous.

Investors’ sentiment toward the oil and gas industry has “certainly changed in the last 30 days,” Ron Ormand, managing director of investment banking for New York-based MLV & Co., told Bloomberg News.

“I don’t think the boom is over, but I do think we’re in a period now where people are going to start evaluating their budgets,” he said

And that could mean cutting back on drilling, although production from wells already drilled would continue to supply oil.

The concern extends beyond the shale plays. In Kansas, which relies on traditional vertical wells, the mood is also cautious.

“It’s something that is on everyone’s mind,” said Ed Cross, president of the Kansas Independent Oil & Gas Association.

But for the U.S. and world economy in general, falling oil prices appear to be a pretty good deal.

Current oil prices, according to Citigroup Inc., would eventually provide a stimulus of as much as $1.1 trillion annually to the global economy, thanks to lower fuel prices.

Brown, the former Federal Reserve Bank official, said the extra cash that consumers and companies can spend on other things won’t be a huge boost for the U.S. economy, but still a plus. He estimates a boost in GDP of 0.3 percent over a couple of years.

But there will be losers.

Besides Texas and North Dakota, it’s estimated that other top oil states Alaska, Oklahoma, New Mexico, Wyoming and Louisiana will be hurt by the declining prices.

The rest of the states and the District of Columbia will gain economically. Among top-10 producing oil states, California, Colorado and Kansas have more diversified economies, which makes them net winners when oil prices decline.

The benefit of lower fuel prices will be spread around — mainly the estimated $500 in gasoline savings for average households — but it’s still a boost for consumers.

“That’s still not a small thing,” said Brown, who is currently director of the Center for Business and Economic Research at the University of Nevada-Las Vegas.

But could the bonus from lower gas prices in the end cost the country?

The U.S. in 2006 relied on net imports of oil and petroleum products to satisfy 60 percent of demand. By 2013 that was cut by nearly half to 32 percent. This year it ducked below 30 percent, and it’s predicted to go to 21 percent next year.

“This situation (we’re in now) reminds me of 1982 or 1983,” said Jay Hakes, former head of the Energy Information Administration and author of a book on energy independence.

By the early ’80s, the country had slashed oil imports before cheap Mideast oil reversed that trend — with oil eventually sinking to $10 a barrel. Fuel consumption came roaring back, and domestic oil companies cut back or shut down. By the 1990s, our dependence on oil imports was greater than ever.

Jessica Caldwell, a senior analyst for the the auto buying website, said there were signs now that fuel efficiency wasn’t quite the priority it once was, including higher sales of SUVs.

“We have seen some of that behavior already,” she said.

Hakes said at current oil prices he believes the progress made to reduce imports won’t unravel. There’s a lot of momentum, from higher oil production to tough fuel economy standards for motor vehicles.

But another big drop in oil prices that stuck around would change things.

“We would have a problem,” he said.

To reach Steve Everly, call 816-234-4455 or send email to

Top oil producing states

(Thousands of barrels per month, from July 2014)

1. Texas96,168

2. North Dakota34,430

3. California17,101

4. Alaska13,091

5. Oklahoma10,946

6. New Mexico10,281

7. Colorado7,079

8. Wyoming6,573

9. Louisiana5,940

10. Kansas,166

29. Missouri17

Source: Energy Information Administration