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COVID-19’s Threat to U.S. Energy Security

The American Interest

The US shale oil industry serves a vital national interest by protecting the country from price or supply shocks. 

For the past decade, the United States has enjoyed a remarkable boom in the production of oil and natural gas. Mainly due to technological advances in fracking, America has become the world’s largest producer of oil as well as a major player with respect to natural gas. Given the role that energy supply plays in international politics, the benefits that accrue to the U.S. from this fact are obvious.

With respect to oil, the United States is a relatively high cost producer; shale oil (produced by fracking) is much more expensive to produce than the oil that gushes forth from the mammoth fields of Saudi Arabia and elsewhere. On the other hand, U.S. shale oil production is much more nimble. Compared to the years and billions required to open new fields, especially off-shore, shale oil wells can be brought into production relatively quickly; at the same time, they degrade relatively quickly as well. Thus, whereas most oil production involves long-term planning and commitments, shale oil can be thought of more like a manufacturing process: When one stops drilling, production falls off quickly, and when one resumes, it can rise relatively quickly as well.

What this has meant, in effect, is that U.S. production has effectively capped the price of oil. When it rises above the level at which shale oil production is profitable (approximately $45-55 per barrel), U.S. production can ramp up relatively quickly and stop or reverse the price rise.

But the obverse of this is that when oil falls below $45, U.S. shale oil production is unprofitable and can be expected to shrink rapidly, endangering the financial health of many U.S. oil companies and posing the threat of widespread bankruptcies in the oil patch. This is what has been happening recently, thanks to both the drop off in demand due to the COVID-19 global slowdown and the “price war” between Saudi Arabia and Russia. Whatever their other motives may have been, both countries had reason to resent the rapid expansion of U.S. oil production and, to put it as mildly as possible, would not be sad to see the U.S. industry decimated.

The presidential strategy thus appears to be one of raising world oil prices in order to avoid the decimation of the U.S. oil industry. This is a completely understandable strategy, but it suffers from some serious drawbacks.

President Trump has recently engaged with both President Putin of Russia and Crown Prince Mohammed bin Sultan of Saudi Arabia, in an attempt to get them to agree to production cuts to support the price of oil. On April 2, the President tweeted that he “expect[s] & hope[s] that they [Saudi Arabia and Russia] will be cutting back approximately 10 Million Barrels [a day], and maybe substantially more.” Today, Opec and Russia reached a deal to cut production by just this number. But even if such extensive cuts can be achieved in practice (and past experience shows it is far from a foregone conclusion that they can), it does not seem like this will be sufficient to save U.S. producers.

In the short term, it appears unlikely that the world oil price can rise to the $45-55 level until the current pandemic is safely behind us. Oil prices did rise in reaction to the President’s tweet and in response to some indications of a Saudi-Russian deal, but not to levels that would ensure the financial solvency of the oil patch. In a situation of vastly reduced demand, it is hard to see how U.S. shale can be profitable.

In the long term, a strategy of propping up prices seems even less attractive. It would mean, in effect, that the U.S. industry could exist only on the sufferance of Russia and Saudi Arabia. It would cause a continuing diplomatic weakness; at any point, either country could raise production and create a crisis in the U.S. shale oil industry.

An alternative strategy would start from the recognition that, by effectively capping oil prices, the shale oil industry serves a vital national interest by protecting the country from price or supply shocks. As such, we should be willing to spend money to make sure that it can continue to serve that function. This does not mean that we should be producing oil unprofitably at current levels when world prices are low; it does mean that we should maintain the capability to ramp up production quickly when prices rise. What “quickly” means in this context depends on the size of the Strategic Petroleum Reserve (SPR): Our policy should be to have a big enough reserve to augment supplies such as to keep prices below, say, $60 per barrel until increased U.S. production kicks in.

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