econpolicy.com

The New York Times reports that the number of oil and gas rigs deployed to drill new oil and gas supplies across the country has fallen to less than 1,200 from 2,400 last summer, and energy executives say the drop is accelerating (“As Oil and Gas Prices Plunge, Drilling Frenzy Ends,” http://www.nytimes.com/2009/03/15/business/15drilling.html?_r=1&th&emc=th).

In the late 1970′s and early 1980′s there were forecasts that both energy consumption and prices were on a permanent upswing. I have an unclassified CIA energy consumption forecast from this era that is representative of such thinking. Natural gas prices were deregulated to encourage increased production. People were urged to conserve energy.  They did.  In a relatively short period of time, thanks to a recession engineered by Paul Volcker, conservation in the face of higher prices and the memory of OPEC’s behavior, prices plunged.  Prices remained low for decades.  People purchased larger automobiles while prices were low and natural gas became the fuel of choice for electricity generation; a physical waste if not necessarily an economic one because other uses capture more of the thermal units available from burning gas.

After the US invasion of Iraq, and in a period of high economic growth, energy prices began to rise again.  More and more foreign oil was imported, but higher prices eventually encouraged more drilling within the US, and especially in areas where natural gas exists, locked in shale, deep into the earth.  The exploration buildup was slow. As explained by those who know the industry, companies are reluctant to commit additional resources to drilling and exploration until they are confidant that an increase in prices is more than temporary.

As one could have predicted from past behavior, when demand and prices collapse, new drilling does also.  And one should expect that if and when energy prices rise again, the buildup in exploration and production will again proceed at a slow pace.  It may be even slower next time because years of low energy prices depleted the supply of skilled workers in the field prior to the recent run-up and collapse of energy prices.

This boom-bust cycle is nothing new in the history of the economics of natural resources and agriculture.  And nothing new in the history of oil drilling either (it was not until the mid-1900s that natural gas became in important fuel). The old “hog cycle” agricultural economics studies are applicable here.

The cycle has devastating effects on regions and states, because they rarely look far enough down the road to put some of the tax revenues aside when high energy prices, increased drilling and higher production are filling their coffers.  Can anything be done about this?  Certainly something can be done. We know how to stabilize commodity prices through various government policies, primarily through the use of taxes, which dampen the swings.  However, anything we do involves trade-offs and American consumers are not very good at accepting this. We want it cheap, we want it all, and we want it now.  Those producing the resources want it untaxed (or tax-preferred) and unregulated. Compromise does not come easy.

We have the means. But thus far we have not had the will.

HEK