Shale Helps Insulate U.S. from Oil Shocks—But Not Entirely

The Arab oil embargo from 1973 is a painful memory for those who lived through it. It was the reason for creating the Strategic Petroleum Reserve in the United States and the International Energy Agency as means of, if not shielding oil-consuming countries, then at least cushioning any future blow.

The U.S. shale revolution changed all that, and it changed it radically. The U.S. has gone from a top importer to the top producer, even as it continues importing quite substantial amounts of crude. The rate of production, made possible by shale projects, has given a much bigger role to U.S. oil on international markets, influencing prices and essentially shielding importers from excessive price movements. But not entirely.

The Financial Times recently published a well-deserved ode to U.S. shale. The ode suggested that the recent exchange of missile fire between Iran and Israel would have upended markets had it taken place forty years ago. Now, the strikes only pushed oil prices higher for a couple of days before their retreat. Thanks to U.S. shale oil.

"Shale has redrawn the map of world oil in a way most people don't seem to understand," the FT quoted Daniel Yergin, vice-chair of S&P Global, as saying. "It has changed not only the supply-demand balance but it has changed the geopolitical balance and the psychological balance."

Indeed, shale has changed the face of the global oil market in more than one way. First, it has provided an important new source of crude oil for markets that wish to diversify for various reasons-take Europe, for instance, the biggest new market for U.S. oil since 2022.

Second, it has provided that much-needed insulation against global price shocks that were previously inevitable when the Middle East caught geopolitical fire, which has been something of a frequent occurrence since the end of the Second World War.

Third, as Yergin notes, it has changed things psychologically. Previously, any volatile event in the Middle East caused panic in the oil market because there were no alternatives to Mideast oil. Now, there are. This has made oil traders less twitchy, lending stability to oil prices. Related: Gas Prices Likely to Keep Falling Ahead of Peak Driving Season

Be that as it may, the price shock insulation is not as thick as many would like it to be. While the U.S. produces the most crude oil in the world and exports growing amounts of it, the country is still a big importer because it doesn't produce enough of all the grades its refineries need.

Yet this is the more negligible problem. After all, the U.S. imports most of the foreign oil it needs from Canada, so supply shocks are quite unlikely. The more important fact when it comes to supply-and price-shocks is that while no single member of OPEC+ produces as much as the U.S., together they still account for a pretty solid portion of global oil supply.

Just the three top-producing members-Saudi Arabia, Russia, and Iraq-pump a combined fifth of global oil. Interestingly, the share of those three is roughly equal to the combined share of U.S. and Canadian oil in global output, yet because of Canada's export limitations, each of the three OPEC+ members has greater sway over oil markets on their own-even more so when acting in concert.

Still, even when they move in concert, as OPEC+ currently does, the effect of production controls on prices is muted thanks to U.S. shale that last December pushed the country's total to an all-time high of 13.3 million barrels daily. There's solace to be taken in the belief that U.S. producers can boost production at any point-even if it is a false belief.

The oil market is not a rational place, and many players in it readily admit that. Oil prices can move based on unconfirmed rumors and speculation as sharply as they move on verified events. Lately, price movements have also been heavily influenced by the use of algorithmic trading, in which it is software that makes the trading decisions, rather than humans. The role of this on price stability needs to be noted alongside U.S. shale as well.

And then there is the ultimate problem-from a U.S. perspective. "We are still acutely exposed to geopolitics and market manipulation. And shale doesn't really help with that," Jim Krane from Rice University's Baker Institute told the FT. "Yes, we're a big producer. But more importantly, we're a big consumer, and that's where our exposure lies."

The United States, per the Energy Information Administration, produces around 15.5% of the world's oil. But it consumes 20% of global supply. And that means that even with the abundance of shale oil, it remains sensitive to price shocks-even if they are blunted by its own supply.

This is what pushed the Biden administration to release close to 200 million barrels of crude from the SPR in 2022, and this is what has led some analysts to suggest it might resort to SPR releases again this year if prices move much higher in the coming months. Because, unlike OPEC+, U.S. oil comes from private companies, and the government cannot tell them when to boost or reduce production. It's up to the market.

By Irina Slav for Oilprice.com

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