What Oil Shock?

Foreign Exposure

There’s a reason that every President since Nixon has pledged to make the United States “energy independent.” It’s the same reason that drives consumers to more efficient cars. It’s the closest thing to a universal truth in energy markets—that unrest in the Middle East is directly proportional to the price of oil.

But this truth is far from absolute. Looking back, it’s clear how it gained traction. In 1973, the OPEC oil embargo triggered by the Yom Kippur war saw oil prices quadruple from $3 to $12 per barrel. A second oil crisis followed only five years later in the wake of the Iranian Revolution; though world oil supply only decreased by about 4%, prices in the Untied States skyrocketed to $39.50 per barrel.

It’s thus not difficult to imagine how a causal link was established between Middle East instability and oil prices. There was seemingly an iron law that linked global prices to supply shocks from the Middle East. Yet global energy has evolved since 1979, and the United States is now the third-largest producer of oil in the entire world. For the first time since 1995, the US produces more oil domestically than it imports (primarily thanks to the shale oil boom in North Dakota and Texas). It’s a completely different playing field that’s reflected in the evolving behavior of world oil markets.

Domestic Insulation

All of this is evidenced in Iraq today. Open The Wall Street Journal and you’ll see headline after headline about Brent crude breaking $114 per barrel due to the Islamic State of Iraq and the Levant’s (ISIL’s) recent territorial gains and takeover of the Baji refinery. But what isn’t mentioned is how much worse this would be without US shale oil production. United States domestic production has surged in recent years, serving to cushion the blows of Middle East instability. The current ISIL-related conflict in Iraq is only one such case. In the context of a well-coordinated Islamic terrorist network gaining ground against the failed government of the second-largest OPEC state, the corresponding increase in Brent crude prices was actually quite moderate. And in the aftermath of ISIL’s rapid progress in Iraq Brent prices have begun to crater, reaching a 3-month low just this week. We have US shale oil to thank.

This is not to say that US oil markets are suddenly completely autonomous. As the price of global crude rises, US gasoline prices will rise along with it.   More troubling is the impact that Iraq’s instability will have on US trading partners; China National Petroleum Corporation, for example, is the Iraqi oil industry’s largest foreign investor. An oil shock that hits China will surely have ripple effects throughout the American economy.

But we should take some degree of solace in the fact that our domestic oil production will help shield us from future shocks. Though it is impossible to entirely isolate US oil prices from the world, shale oil has helped the Untied States reap dividends far beyond barrels and gallons of crude.