To consumers of a certain age, OPEC conjures up memories of Jimmy Carter wearing a sweater and motorists lined up at the gas pump.
The oil cartel doesn’t seem so fearsome anymore. Last week, after discussing how to react to a 30 percent drop in prices, OPEC members decided to do nothing. Prices immediately fell further, sending U.S. crude below $70 a barrel.
The result will be a windfall for American consumers but a problem for the shale-oil industry, which has used fracking technology to drive U.S. oil production to a 25-year high. Many drilling projects that are profitable with oil at $100 become money-losers at lower prices.
In fact, some people think Saudi Arabia, the dominant OPEC producer, is willing to absorb lower prices to keep the U.S. from grabbing a bigger share of the world oil market. If that’s the strategy, it will require a lot of patience on the part of cartel members.
“You’re going to see some future investments not made, but it may take a couple of years before you see a significant slowdown in the growth of U.S. production,” says William O’Grady, chief market strategist at Confluence Investment Management in Webster Groves.
Notice that he said “slowdown in growth,” not “cut in production.” Wells that are already producing will remain online, and most drillers won’t abandon projects they’ve already started. Many of them used hedging techniques to protect against a drop in prices.
Only as the drillers consider new investments do the lower prices have an effect. Even then, not all projects are alike.
Companies will shift resources toward their most productive fields and away from riskier, higher-cost exploration.
So the Saudis, who claim they’re allowing prices to find a new equilibrium, can expect a long period of financial pain ahead. So can other big oil producers such as Venezuela, Iran and Russia. That may lead to political instability in some parts of the world — and the price spikes that go along with it. “This is a big budget hit for some of those countries,” says James Williams, an energy economist with WTRG Economics in London, Ark. “The chances of revolution have just increased.”
Meanwhile, U.S. motorists can smile as they pull up to the gas pump. O’Grady says retail gasoline prices don’t yet reflect all of the drop in crude prices, and may even fall below $2 a gallon.
When we imported almost three-fourths of our crude oil, it was easy to say that a lower price was good for the U.S. economy. Now that the U.S. produces nearly half of its oil needs, the economic analysis becomes a bit more ambiguous.
If drilling slows, that means fewer jobs in oil-rich states such as Texas and North Dakota.
Still, the benefits to consumers probably outweigh the profits lost by domestic oil producers. “I think all of this is a net plus to the U.S. economy, although maybe not as much of a plus as it used to be,” says Joel Prakken, chairman of Macroeconomic Advisors in Clayton.
As a rule of thumb, he said, a $10 decline in crude prices might increase growth in gross domestic product by a quarter of a percentage point.
Since we’ve seen prices fall by more than $30 a barrel, the economy should feel a nice tailwind at the start of 2015.
And the best part is that OPEC can do nothing to stop it.