Full text of Energy Highlights : July 1986

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DALLAS
Federal Reserve Bank of Dallas

July 1986

Lower Prices May Enhance Future Energy Independence
Lower oil prices stimulate consumption and deter production of the
nation 's oil reserves, with potentially
adverse affects on domestic energy independence. One factor often ignored ,
however, is that lower prices prolong
the life of the nation 's oil reserves ,
making more oil available in the future.
The relative effects of lower prices on
consumption , production, and reserve
development depend on expectations
about future prices. Delaying production of domestic oil reserves now
because of lower prices could nevertheless enhance the nation 's future
energy independence.
Prices Affect Reserves

Falling prices affect reserves of
crude oil in two ways. First , lower
prices reduce the incentive for energy
firms to explore for new reserves of oil ,
as the sharp decline in the number of
operating drilling rigs in 1986 shows.
Other factors being equal , lower prices
can be expected to lower proven crude
oil reserves. Alternatively, lower prices
affect the level of reserves that producers can extract profitably. Falling
prices make fields with higher production costs unprofitable. Thus, the level
of economically recoverable reserves
also drops when oil prices fall , but the
large majority of the reserves that
become uneconomical to extract at
lower prices remain available for production should prices rise later. Lower
prices thus can delay extraction of oil
that is more costly to produce unti I the
time when it is more valuable-when
the price of oil from other sources is
higher.

Domestic Reserves Show
Declining Pattern

The United States has experienced
declining reserves relative to production levels for several decades. With
the exception of the discovery of large
fields on the Alaskan North Slope in
the early 1970s, reserves in terms of
years of production have fallen steadily since 1960 (see Chart 1). Even during
the 1970s and early 1980s when rising
prices induced increased exploration
activity, the ratio of reserves to production declined. This decline occurred
because most U.S. reserves were discovered relatively early in the country 's
energy-producing history. Since the
mid-1900s, production in most years
has more than offset new discoveries,

thus leading to the fall in reserves .
Other countries have increased their
oil reserves while the United States on
net has depleted them . The growth of
non-U.S. oil reserves is shown in Chart 2.
At the current level of oil prices,
other countries can produce oil from
their reserves more economically than
the United States can try to add to its
own reserves. Policies such as an oil
import tariff to encourage exploration
would also promote production , with
the likely effect of offsetting additions
to U.S. reserves. Lower prices , despite
their stimulus to consumption , may
make the country more energy independent later by deferring extraction of
available reserves .
- William T. Long Ill

Energy Investment Estimates May
Overstate Current Economic Strength
Falling oil prices can be expected
eventually to cause more rapid
economic growth in the United States.
However, because the negative effects
on the domestic energy sector occur
before the positive effects on energy
consumers can be realized , the expected growth surge is not likely to
materialize in the near term. Although
some of the negative effects of the
slumping energy sector have been captured in the GNP accounts, estimation
methods may have underestimated the
decline in energy investment. Consequently, the current strength of the
economy may have been overstated.

Oil Prices Affect Investment

Lower oil prices spur economic
growth by reducing both the cost of a
major production factor and the cost of
petroleum products to consumers. Although some of the gains appear immediately as consumers need to spend
less income on fuel , most of the gains
take time-especially in investment. In
the short term , energy-consuming industries do not invest immediately in
new equipment to take advantage of
lower oil prices, but energy-producing
industries are pressed to reduce investment in exploration and development.
(Continued on back page)

Chart 2
MIDDLE EAST AND FREE WORLD RESERVES

Chart 1
U.S. RESERVE-PRODUCTION RATIO
13.0 YEARS OF P R O D U C T I O N - - - - - - - - - - - -

.........

.····· .

105

11 .7

/'··

140(1970-79=100) - - - - - - - - - - - - - - -

10.4

9.1

. · / ~;;,.E~~~~~E~x;~~DING
MIDDLE EAST

....··············
18
·

I 15'0 1I I 15'51I I 160 1I I 165 1I I 17'0 1I I 175 1I I 18ol I I la's

NOTE: After 1980, U.S. Department of Energy estimates were changed to a

0
SOURCES: American Petroleum Institute.

different base for computing reserves .

OU and Gas Journal.

SOURCES: American Petroleum Institute, 1948-80.
U.S. Department of Energy, 1981 - 85.

Chart 3
INVESTMENT IN OIL AND GAS WELL DRILLING
32PERCENT----------------~

PERCENT OF TOTAL
INVESTMENT IN
NONRESIDENTIAL
STRUCTURES

Chart 4
FOOTAGE DRILLED AND THE U.S. RIG COUNT
160 ( 1 9 8 0 = 1 0 0 ) - - - - - - - - - - - - - - - -

120

·······.. ·············...

·.. / .... / .....................··...

···········...

..........................................- PERCENT OF TOTAL
NONRESIDENTIAL INVESTMENT

SOURCE: Board of Governors, Federal Reserve System.

SOURCES: Board of Governors, Federal Reserve System.
Hughes Tool Company.

U.S. SEISMIC CREW COUNT

WELL PERMIT APPLICATIONS

550 CREWS - - - - - - - - - - - - - - - - - (SEASONALLY ADJUSTED)

4 THOUSAND APPLICATIONS---------(SEASONALLY ADJUSTED)

440

330

2
/ / ......

220

___OKLAHOMA
___ _.....
.,,,.

......

LOUISIANA ..,.

1984

1985

SOURCES: Society of Exploration Geophysicists.
Federal Reserve Bank of Dallas.

1986

/ - .......

--/
.- ·-·"·-·-·,... . ... . .

,,,,,.-,

'-"' -·- · - ·~ - ~·- · - - .

1984

1985

SOURCES: Louisiana Office of Conservation.
Oklahoma Corporation Commission.
Texas Railroad Commission.
Federal Reserve Bank of Dallas.

1986

ENERGY BRIEFS
• Oil prices have firmed in recent months as a
result of higher seasonal demand , but such demand has been weaker than expected . Although OPEC ministers agreed in June to an
overall output quota, they failed to agree to
country-by-country limits, thus dampening the
prospects that prices will rise before the next
seasonal demand increase this winter.
• Despite two weekly upturns in the rig count in
June, the monthly average of this indicator continues to decline as a result of falling oil prices.
Both the Texas and U.S. counts have fallen
more than 60 percent below their year-earlier
levels.
• A sustained recovery of drilling remains highly
unlikely in the near future, as suggested by
continued declines in leading indicators of
drilling-seismic crew count and number of
well permit applications . The number of

ROTARY DRILLING RIGS RUNNING

seismic crews in May was only slightly more
than half its year-earlier level , and declines in
well permit applications also accelerated.
• Falling oil prices have caused severe dislocations in energy-related industries. Oil and gas
extraction employment in May was almost 20
percent below its year-earlier level , showing a
sharp 15-percent drop since December alone.
During the same two periods, oil field
machinery manufacturing lost 30 percent and
23 percent , respectively , of its workforce.
• Higher world oil production and lower crude oil
prices, while leading to increased output by
refiners , has not bolstered employment. Although capacity utilization at the nation 's
refiners , at 87 percent , is at its highest level in
over two years , refining employment continues
to trend down because more labor-intensive
operations have been shut down.

SELECTED CRUDE OIL PRICES

(SEASONALLY ADJUSTED)

36 DOLLARS PER B A R R E L - - - - - - - - - - - - -

UNITED STATES

1,950

___ .,,. .... --- -- .... _
_

1,300
.- ·- ·- .

650

28
'\ U.S. REFINER
\ ACQUISITION
\COST FOR
\DOMESTIC OIL

REGIONAL STATES'

-----

- ·- TEXAS
.- ·- ·- .- ·-·-.

1984

-·-.

1985

1986

1984

1985

1986

1. Louisiana, New Mexico, Oklahoma , and Texas.
SOURCES: Hughes Tool Company.
Federal Reserve Bank of Dallas.

SOURCES: I. P. Sharp Associates.
U.S. Department of Energy.

REFINERY PRODUCTION

TEXAS ENERGY EMPLOYMENT

112 (1984=100) - - - - - - - - - - - - - - - (SEASONALLY ADJUSTED)

110 ( 1 9 8 4 = 1 0 0 ) - - - - - - - - - - - - - - - -

- ·-· ·-...... ....·-·-·- .

100

105

(SEASONALL Y ADJUSTED)

-- .... .... ....

'- .... ,,,,.- ...................

· OIL AND GAS
\EXTRACTION

PETROLEUM REFINING\

. 90

__ _
I
I

I
I
I

"------- ~

1984

1985

SOURCES: Board of Governors, Federal Reserve System.
Federal Reserve Bank of Dallas.

1986

1984

SOURCES: U.S. Bureau of Labor Statistics.
Federal Reserve Bank of Dallas.

1985

1986

Investments (cont.)
Because of the relative importance
of the energy sector in total investment, the positive effects of lower oil
prices are more than offset by the negative effects in the short run on oil and
gas drilling investment. As shown in
Chart 3, oil and gas well drilling has exceeded 25 percent of nonresidential investment in structures and 10 percent
of total nonresidential investment.
Although the share has fallen in recent
years, oil and gas well drilling remains a major component of total
investment.
Drilling Investment Falls Off Sharply
Energy investment has fallen sharply in 1986. Drilling activity, as measured by the rig count, is down over 60
percent from the first of the year and
continues to fall. Furthermore, exploration and production budgets are still
being reduced as hopes for prices
above $20 per barrel diminish.

The full effect of depressed oil and
gas drilling investment on measured
GNP, however, has not been captured
in the statistics. Oil and gas investment figures are based on estimates of
footage drilled, which have not fallen
as severely as the rig count (see Chart
4). Because of probable changes in
reporting practices, the decline in
footage estimates is likely to be
underestimated.' Consequently, actual
investment in the energy sector may be
weaker than the estimate would suggest, making overall investment and
economic growth slower than reported.
Revisions Will Show
Greater Weakness
In the June 1986 GNP revision, the
first -quarter estimates of oil and gas
investment were reduced by 4 percent
from the previous estimate. Further
downward revisions are also likely as
evidence mounts that estimates of

footage drilled are overly optimistic,
forcing estimates of GNP to be reduced. Furthermore, as long as oil
prices remain low, weakness in energy
investment will continue to act as a
drag on overall economic growth.
-Ronald H. Schmidt

1. Estimates of footage drilled are taken from
reports filed by drilling contractors after a well
is completed. Because the reports may be filed
years after the well is completed , estimates of
current monthly footage are obtained by ex·
trapolating returns already received using past
reporting patterns. However, reporting lags
change over time as the time available for keep·
ing up with reporting responsibilities changes.
With the present downturn in drilling activity,
reporting lags can be expected to shorten. As a
result, curre nt estimates based on old report·
ing patterns will overestimate total footage
because the percentage of reports received in
initial months will be higher than average.

The views expressed are those of the authors and do not necessaril y reflect the positions of the
Federal Reserve Bank of Dallas or the Federal Reserve Sys tem .

Full text of Energy Highlights : July 1986

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