Plunging Crude Prices: Regional Effects of Lower Oil Prices

Improved efficiency, Mine Kuban Yücel notes, has allowed oil production to increase despite using fewer rigs. She presents a comparative look at U.S. oil fields’ production rates and costs and notes that labor costs go down as drilling rigs become fewer and cheaper to operate. In regions that do not rely heavily on oil production or refining to support their economies, lower oil prices result in more disposable income for consumers and lower energy costs to all industries. However, in regions whose economies are dependent upon the oil industry, layoffs dampen consumer spending and cause industries to cut capital expenditures. Yücel also discusses impacts on GDP and inflation.

Presentation (PDF)

• Part 1: Julie Stackhouse, Introduction and Welcoming Remarks (5:27)
• Part 2: Speaker Introduction and Overview (9:57)
• Part 3: Effects of Increased U.S. Oil Production (10:00)
• Part 4: Regional Effects of Lower Oil Prices (10:54)
• Part 5: How U.S. States Fare; Oil Price and Consumption Forecasts (11:12)
• Part 6: Audience Q&A (32:32)

Transcript

Mine Kuban Yucel: Okay, well so how has oil production responded to the fall in the rig count? Not. Has not responded. We are still producing. Output actually is up very slightly, maybe flattened a little bit let's say. The latest number isn't up there. So it has continued to increase despite the fall in the rig count, although at a slower rate. So why is that? Well because the current rigs are much more efficient and the horizontal wells much more productive than the old traditional wells. And in the past couple of years that efficiency has actually even increased. What you see here is how much each well produces and in the Bakken, which is North Dakota, and in the Eagle Ford, which is south Texas, the output has gone from about 200 per well to 500 barrels per well. So quite a bit of an increase. The Permian Basin, which is the green there, is not as productive. It's an older shale place, and older plate and the geology is such that it's not as productive. So the Energy Information Administration estimates that the number of rigs that are necessary to sustain production in the Eagle Ford is about 200. And it's about 120 in the Bakken.

So as we go forward, as this rig count starts coming down and it is, we're not going to see any increases in production but we may not see huge declines in production either until we hit that threshold and then we may see the decline.

So how low can these prices go before production starts going down? Well the break-even costs are pretty different for the different areas. These numbers are with a 10 percent rate of return. So there was a study done by the North Dakota Interior Ministry or Department of Mineral Resources and they came out with this range: $28 to $85 per barrel. Now that's a pretty big range. Now they also said though that current prices are below breakeven in all but two counties in the Bakken. But these two counties have 50 percent of the rigs. And so now this was of course a couple of months ago so the prices have now come down. Now the EIA also has said that most production in the Bakken remains profitable until oil prices go down to $42. And the McKenzie County, which is the most productive county, has a breakeven price of $28. So the Bakken is going to be producing from some of these counties and right now it's going to be profitable.

So for the Eagle Ford and the Permian Basin we don't have that much research but the breakevens depend on which study you look at. But for the Eagle Ford it's about $46 to $80 per barrel and for the Permian it's about $52 to $75 per barrel.

I read yesterday or the day before one of an oil company CEO was saying breakeven costs are a moving target. And the reason for this is as oil production ramps down or the rig count falls it gets cheaper. The rigs are cheaper. The wages are less. So the breakeven costs go down too. But right now this is sort of the estimate that we have.

So the shale boom has increased the importance of oil and gas to the U.S. economy, and one way to see this is to look at the share of oil and gas in U.S. GDP and U.S. employment. So the red line is employment share of oil and gas. And you see that it hit a high in the '80s. It was about—that's the right hand axis—so it was about .8 percent and then it came down in the '90s and then has picked back up at about .35 percent. That's the employment.

For output, again, it's a pretty similar trend. That's the blue line and it was about four percent in the first oil boom. Came down to about one. Now is about two percent. So it's pretty important but it's a pretty small portion of the economy as you can see.

So we looked at energy activity. Now what does this mean for the overall U.S. economy? Well overall U.S. economy is impacted quite favorably by lower oil prices. Lower prices, the consumer has more disposable income. And you have to remember that gasoline and diesel account for about 65 percent of all oil consumption. So when gasoline prices fall at the pump the consumer has more money to spend. And the EIA has estimated that these low prices add about $550 per household this year, in 2015, compared to last year. So that's not a small amount but also another point to make here is that gasoline is a larger share of lower-income households' budgets. So and these households usually have a higher propensity to consume. So when they have more money in their pocket because of lower gasoline prices they tend to spend. So we expect that retail sales, for example, may go up.

Now the falling prices reduces the cost of energy to firms, which is a positive. But of course also reduces the profitability of producing oil. And well, maybe you don't hear it here in St. Louis but in Texas we see this every day. Companies are laying off. Schlumberger is going to lay off about 9,000. Baker Hughes is laying off thousands. Halliburton is laying off. And the small companies which don't get as much media are laying off people. So you're seeing a lot of layoffs and you're also hearing that they are cutting their capital expenditures. So every firm about 20 to 40 percent decline in capital expenditures. Pioneer just announced yesterday that they were cutting theirs by 40 percent. So it's a lot of expenditure on, well capital expenditures that are going down because of this fall in oil prices.

Now what is the impact overall on U.S. GDP? It depends on the model that you have but the range is a 50 percent fall in oil prices can lead to a .3 to one percent increase in GDP if the price stays around this level for about a year or so. So it's a positive impact on overall GDP. Headline inflation of course also falls because of lower oil prices.

So what about the states? Well how a state is impacted depends on whether they're a producer or if they're a consumer. And so in states that have oil production the oil boom has been a major, major driver of growth. Largest impact of course has been the local economies where all this drilling is going on. When energy prices go up you have the oil and gas employment. You have the support services employment. But then the oil and gas industry is very capital intensive and economists, we call it they have large multipliers, which means for every job in the oil and gas industry there are jobs that are created in other industries such as business and professional services which is legal, accounting, finance, construction even, and leisure and hospitality.

So the other point here also I should make is that the oil and gas industry has the highest wage among all the other industries, so it brings a significant amount of income into these local communities. And of course then the local governments have greater sales taxes and state governments have increased severance taxes so it really benefits the producing region and state quite a bit. And I'm going to give you an example from Texas. So here's Permian Basin employment. This is employment in the Permian Basin. That's the oil-producing counties in the Permian Basin. That's the blue line. And this is indexed so this is looking at employment growth. And then the red line is rest of Texas taking that Permian out of there. And you can see that the growth in the Permian counties has been quite a bit higher than in Texas as a whole. And the number is 13 percent in the Permian versus about eight percent in Texas.

Now we talked about the counties. In the areas that are producing Midland is in the middle of the Permian Basin. Midland, Odessa. So in 2012 in terms of personal income growth Midland had 12 percent growth. It was number one in the country. And Odessa was second. It was 11.5 percent. So you can say well okay, these are tiny places so you're going to get a high increase in growth. But in terms of level, per-capita income in Midland in 2012 was $83,000. It was number one in the nation so it was more income than New York; it was more income than San Francisco, Washington, D.C., whatever. It was number one. We'll see what happens in—we don't have 2013 numbers yet but you know that's going to go down.

And also retail sales I said these guys have a lot of income because it's high wages. Well you can see how retail sales have increased in Midland, not Midland but the Permian counties versus the rest of Texas, 60 percent for the Permian counties versus 27 for the rest of Texas. So local economies have really benefitted.