October 11, 2011
How North Dakota Became Saudi Arabia & How to Keep It That Way
The Wall Street Journal's recent Weekend Interview was of particular interest to me, and I thought it worth mentioning. The article was titled, How North Dakota Became Saudi Arabia: Harold Hamm, discoverer of the Bakken fields of the northern Great Plains, on America's oil future and why OPEC's days are numbered.
It's an interesting interview with Harold Hamm, who is the founder and CEO of Continental Resources. Mr. Hamm is certainly a leader in the U.S. oil resurgence, and his views carry a lot of weight in many circles. His facts are hard to refute, though I might put a little different spin on it. Here's a key part of the article:
One reason for the [U.S. oil industry] renaissance has been OPEC's erosion of market power. "For nearly 50 years in this country nobody looked for oil here and drilling was in steady decline. Every time the domestic industry picked itself up, the Saudis would open the taps and drown us with cheap oil," he recalls. "They had unlimited production capacity, and company after company would go bust."
This is certainly true. OPEC cannot dictate the market in the same way as they once could, because the market for oil has increased so dramatically, especially in India and China. As such, increased production will simply lead to modestly lower prices, as emerging markets take all the oil the market is willing sell. The article continues:
Today OPEC's market share is falling and no longer dictates the world price. This is huge, Mr. Hamm says. "Finally we have an opportunity to go out and explore for oil and drill without fear of price collapse." When OPEC was at its peak in the 1990s, the U.S. imported about two-thirds of its oil. Now we import less than half of it, and about 40% of what we do import comes from Mexico and Canada. That's why Mr. Hamm thinks North America can achieve oil independence.
This is true, too, although there is an implication here that OPEC is no longer a factor. That's not true, just because their market share had dropped. Most certainly, OPEC's ability to impact price in the ways it did in the 1970s, 1980s, and 1990s, has been diminished. Still, OPEC is a power player, and the revenues U.S. oil companies are seeing are coming into OPEC, too. After all, it's nice to have 80% market share of a $1 million industry, but it's better to have 20% of $10 million market. Of course, here were talking about a lot more zeroes than that.
Further, oil independence has its appeal, certainly, but it's not all it might seem. In this instance, the only reason we might be able to achieve independence from foreign-sourced oil is because oil prices are so high. Are we really better off being energy independent with oil at $90 per barrel, or would the U.S. economy be better served with Saudi oil at $25 per barrel? At $25 or even $50 per barrel, the broad-scale U.S. oil industry can't compete with other world producers.
But the market has changed. Mr. Hamm is right that the U.S. oil industry doesn't need to worry about the boom-and-bust cycle of years past because the price is not going back to $25 per barrel. The new market is great for him, great for those with new jobs, and great for those cashing royalty checks. And it's been great for many parts of North Dakota. I appreciate all of that, and I think regulators, politicians, and citizens should be looking at these facts as they consider energy and other economic policy.
Mr. Hamm finally argues that taxes are likely to stop drilling. He explains:
The White House proposal to raise $40 billion of taxes on oil and gas—by excluding those industries from credits that go to all domestic manufacturers—is also a major hindrance to exploration and drilling. "That just stops the drilling," Mr. Hamm believes. "I've seen these things come about before, like [Jimmy] Carter's windfall profits tax." He says America's rig count on active wells went from 4,500 to less than 55 in a matter of months. "That was a dumb idea. Thank God, Reagan got rid of that."
Here's where we diverge. I am not arguing that President Carter's windfall profits tax had an impact -- it was not good policy at the time. But that was in part because of OPEC's market power. The U.S. oil industry was operating in the zone where the profit margin was such that the tax rate could impact drilling. From what I understand, most North Dakota oil drilling is profitable with oil at about $65-$70 per barrel. Thus, at $85 per barrel, there's a lot of room to increase taxes without having an impact on the drilling. I'm not suggesting that a large new tax would be a great move, but it's not likely to have the dire consequences it could have had in years past. I'm at least okay with the status quo here. Perhaps we would get more drilling if we added more incentives to oil exploration, but my suspicion is that we would be rewarding people for doing what they were going to do anyway.
I think the energy industry, including traditional resources, is vital to U.S. economic interests, and I think our policies should support the current growing and evolving oil and gas industry. I happen to think there is room for everyone. My biggest worry for the oil and gas industry is that someone gets careless with their new drilling methods and causes a major environmental disaster. The harm to the environment would be a major concern, of course, but I think most people want that protected. This is not news.
The greater harm to the industry, and the economy, though, of such a disaster is often missed. The economic key to this oil and gas boom is to keep it going -- and the biggest threats are no longer OPEC, taxes, or the electric car. It's an environmental disaster that leads to a large-scale shutdown. That would be the ultimate lose-lose situation.
Horay for convergence of factors that revive domestic oil & gas exploration, development and productions for increasing reliance on domestic oil & gas and producing domestic energy jobs and profits. We do not need a sudden attention to O&G profits to attract the government like a flock of seagulls at a beach picknick to squash a nascent surge in domestice O&G. Folks know how to do it clean, and if one fails to be clean, let's not shut down all over it. Closing the Gulf drilling over one bad well in the middle of a depression may be the nail in the cofiin for Obama's conflicted recovery efforts. It certainly threw a wet blanket on economic recovery and business sector confidence in the Government's support of a private sector recovery.
Posted by: Wayne Isaacks | Oct 12, 2011 10:24:24 AM
So long as the tax is on profits accurately calculated and the tax is a minority of the profit earned, the incentives related to tax law won't stop production unless the industry doesn't believe that the tax will stay on the books for very long.
Posted by: ohwilleke | Oct 13, 2011 7:31:52 PM