The role of energy in economics - Carlos González

8/10/2019 The role of energy in economics - Carlos Gonzlez

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Carlos GonzlezUNIVERSIDAD AUTNOMA DE MADRID |

The role of oil in US economyOIL DEPENDENCY IMPLICATIONS ON THE TRADE BALANCE ANDHOW SHALE GAS CAN HELP TO STABILIZE.


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Universidad Autnoma de Madrid

Facultad de Ciencias Econmicas y Empresariales

Maestra en Economa Internacional

Historia de las relaciones econmicas internacionales

Ciudad Universitaria de Cantoblanco, 28049 Madrid

http://www.uam.es/ss/Satellite/Economicas/es/home

[email protected]
http://www.uam.es/ss/Satellite/Economicas/es/homehttp://www.uam.es/ss/Satellite/Economicas/es/homehttp://c/Users/cargoa/Google%20Drive/UAM/COURSES/History/[email protected]://c/Users/cargoa/Google%20Drive/UAM/COURSES/History/[email protected]://c/Users/cargoa/Google%20Drive/UAM/COURSES/History/[email protected]://www.uam.es/ss/Satellite/Economicas/es/home


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Index

Abstract ........................................................................................................................................... 2

1. Introduction ............................................................................................................................. 4

1. Just a while before it................................................................................................................ 52. First days. ................................................................................................................................. 6

3. Becoming an energized, rolling an unstable world. ................................................................ 9

4. Big bang of oil industry and markets ..................................................................................... 13

4.1. OPECs role..................................................................................................................... 16

5. An oiled trade balance? ......................................................................................................... 20

5.1. Exterior deficit analysis .................................................................................................. 24

6. Fracking the economy ........................................................................................................... 267. Conclusions ............................................................................................................................ 29

References .................................................................................................................................... 30

Illustration list ............................................................................................................................... 33

Abstract


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World economy changed tremendously from the 19thcentury to the 20thmodifying completely

the way people produce and consume. One of the principal vectors of this turn has been energy

as a mean of power for satisfying our needs and the way of living. We present in the following

lines a quick review of how the discovery of petroleum influenced the energy field, production

sector, the global share of goods and services, the economic geopolitics and the live of all,

focused on the United State case study. A variety of constructed timelines will bring you through

the timeline up to this date making a prospective exercise of what oil holds ahead for us.


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1. Introduction

Man working and animals pulling were the main source of energy before the first industrial

revolution back around 1770 in England with wind, water and lumber as reduced fuels. The steamengine, coal, the locomotive, oil, electricity, the automobile and some guys known as Watts,

Tesla, Edison, Drake, Rockefeller, Ford among others have brought us from an agricultural driven

world in the XVII century to an energy dependent one led by just few economies, mainly the one

of United States of America.

Since the discovery of petroleum wells at Oil Creek in Pennsylvania in 1859 the national

production rate increased in an enormous way leading the impressive growth of the US industry,

production that reached in 1938 64% of world production, 5 times more than the Soviet Union

who was the second world producer. (Energy Policy, 2011)

Oil consumption, in great part used for transportation (Stephen Land - The History Channel, 2010)

became an insatiable need for Americans and National Production wasnt enough for satisfy it in

1950 US still accounted for 52% of global production ending in 1960 when it became a net

importer of oil. Since then, as well as the positive GDP, the negative trade balance hasnt stop

neither their need for oil. Nowadays the black gold is the largest traded commodity in the world

and its industry is also among the very first ranked. (Parra, 2009)

Recent economic crisis have produced an important deficit in the American economy, reaching

levels considered by many as unmanageable (Fernndez, 2007) arising an important global

discussion of how much can be supported and what measures they have to implement to turnthe direction of this negative vector. US deficit reached 6% in 2006, accounting 3% in 2012 (IMF,

2014). However, when everybody thought that American oil production was downsizing without

return impacting even more the deficit, a new technology for capturing and pumping deeper oil

sources has emerged making to raise the American oil production again and projecting a large

amount of reserves that could lead to enhance the trade balance again. In fact, shale oil has

contributed to 28% crude oil production increase passing from 5 millions of barrels per day in

2007 to 6.4 mbbl in 2013.

Thus, we present in this document an outline of the weight of energy, more specifically oil, in the

American recent history, and how it has impacted on growth and deficit of its economy. Well

draw a resumed timeline discussing the most important milestones of energy in US history,

reviewing the main actors of its development, how prices drive modern economy and how it

became maybe the most important element in global geopolitics for the recent years. The

document is divided in different periods from the discovery of the first well to the shale oil now.

Well emphasizeon the relationship of oil and modern economy, following the oil price index


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timeline making a focus on crisis, shocks, and conflicts. Finally closing with the analysis of the

deficit and the possible shale gas impact on it.

1. Just a while before it

It is been told several stories about the first appearance of this black mass, from the bible

mention of the used of bitumen for the Noahs ark (Stephen Land - The History Channel, 2010)

and then in several other times for instance in the ancient Mesopotamian civilization, more than

5.000 years ago, where is believed that a resource coming from earths was used for construction

of temples, ships and water tanks. (Forbes, 1936) (Whiteoak & Read, 2003)

There are also references for ancient Persia and Sumatra were oil was considered to have medical

benefits, for purge, rheumatism, cramps, cough and so many others even to be though the cure

of leprosy as is quoted on Lescaroux & Rech work (Oil Economics, 2013): Drunk as bituminouswater it breaks up blood clots and causes abortions. Spread on cattle and beasts of burden, it

cures mange and Pliny write that the Babylonians believed it to be good for jaundice and for

whitening the eyes. They also believed it to be a cure for leprosy, eruptive and itching skin

diseases. It is used as an ointment for the gout.(Agricola, 1546)

In the same work Lescaroux & Rech mention different evidences of its use as for example for

mummification in Egypt (1000 B.C. to 400 A.C.), adhesive, jewelry, weapons, lighting,

waterproofing, medicines and heating in Persia and China, Russia or by Native Americans in

different epochs. As we can see, it has quite stories which are not purpose to describe in this

report, given that neither of them make a minimal impact in society as in modern times.

Before going forward to the first days of the petroleum as a source of energy, as we know it now,

we can comment the first indications of a comparable use, it was the Chinese civilization, around

400 A.C. made the first oil drills, pipelines made of bamboo and networks of it (1000 A.C.). A

century before Persians alchemist made a distillation of oil in an alembic obtaining kerosene,

which made the path to this king of light lamps. (LESCAROUX & RECH, 2013). Samuel Kier, the so

called Grandfather of the Oil Industry in America developed a medicine named Kiers Rock Oil

sold around 1849 for 50 cents the bottle. (Mann, 2009). And then, in 1853 Francis Brewer took a

sample of Rock Oil, from Oil creek to the chemical department of his university Dartmouth

College where George Bissell, another fellow student, in a visit to the school crossed by a sample

of this liquid and send it to the University of Yale. Professor Benjamin Silliman suggested that the

Kier Rock Oil could be distilled to produce kerosene. Bissell end it up buying some acres in the

area and organized the first company of oil called the Pennsylvania Rock Oil & Co in 1854.


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2.First days.

Bissell was the first one to envisioned profit for selling the kerosene for lighting, (Stephen Land -

The History Channel, 2010) but he needed funding for guaranteeing supply which required,according to his project, to drill the ground and obtain more quantity of the black oil. As usually

happens no much people believed in this kind of ideas, but he persisted hiring his future partner

Edwin Drake a former railroad conductor to drill his oil field. Drake was sent to Titusville working

for the former Penn Rock Oil & Co, now Seneca Oil Co, where after several failure attempts Drake

brought a Kiers Rock Oil employee William Uncle Billy Smith who finally pumped the first oil

well in 1859. (Mann, 2009)

In parallel Kier also went to the University of Pennsylvania in Philadelphia and professor Curtis

Booth recommended to distil the oil and produce illuminant to compete with whale oil for

lighting lamps. His cheaper product, made in a tiny adapted whisky distillery, was now calledcarbon oil and with his previous selling experience, he obtained increasing acceptance of his

special lamp with oil rock illuminant (which came with a special lamp) driving these to the first

sales of oil as energy source in America. Another pioneer, Charles Lockhart who in 1961 built the

first commercial scale oil refinery, produced 250 barrels a day making the starting point in the

industry and the birth of a new economy to come. (Mann, 2009)

While before Kier, Drake and Lockhart were working in USA, in the other side of the ocean, Ignacy

Lukasiewicz using Dr. Abraham Gesner techniques also produced kerosene in 1853 from wells in

Poland and in Romania 4 years later where they built their first distillery which product was used

in public lamps of Bucharest. (LESCAROUX & RECH, 2013)

Nevertheless, the big guy of the oil industry was still to come a 23 years old born in the state of

New York, whose first work was as bookkeeping and has the name of John Davidson Rockefeller.

(Chernow, 1998). It was in 1862 when he first arrived to Titusville and soon he founded in

Cleveland, Ohio a small refinery where they improved the method using sulfuric acid for avoiding

the lamps to smoke. They soon founded the Standard Oil Company of Ohio with a value of

1.000.000 USD grouping two refineries and a distribution company altogether managed just 10%

of Cleveland total refining capacity. (LESCAROUX & RECH, 2013).

Doing a parenthesis, its important to mention another key element in the economy of these

days: the locomotive. A British invention of Richard Trevithick, that lead to the first successful

train made by George Stephenson using steam technology was introduced in Baltimore in 1828

with direction to Ohio (U.S. History, 2014), becoming an essential driver in the Industrial

Revolution, and of course in the nascent oil one.


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Honoring the name of the company, Rockefeller made huge effort in standardizing the product

following to obtain a high quality product and a good image of his company. It is believed that

great part of his success was due to his high standard of organization and an accurate

understanding of the market. Moreover, the railroad would soon became one of the main factors

enabling Rockefeller to reach such growth when analyzing the costs of his product he observed

that the rail transportation made the product more expensive compared to the oil produced in

Pennsylvania (LESCAROUX & RECH, 2013). In response, the efforts were concentrated in a

partnership with the surrounding refineries of Ohio creating the South Improvement Company

that negotiated a large discount in the transportation cost with the railroads companies. During

this period a bunch of competence moves are accounted to be made by Rockefeller with the

railroads: in a multidirectional string fight between competitors bribery, profit pressure,

agreements of sharing competitors information and other much or less controversial methods

were made by business players (Micheloud, 2014). HE started to control more and more the

refinery business (1/5th), companies from Pennsylvania begun to build a pipeline to New York and

John responded buying the pipeline company.

By 1877 Standard Oil controlled more than 90% of the oil refineries and in 1900 between 80-90%

of the transportation and distribution business, keeping relatively cheap prices between 0.7$ and

1$/bbl. (LESCAROUX & RECH, 2013) (Popove, 2010). It was a growing but still reduced industry in

the United Stated by that time. Expansion to other countries became a reality selling oil to

Europe, Latin America, South Africa and China. With almost with no competition in the sector,

the industry encountered one competitor from another side; a huge one.

The high consuming city of New York received the first public use electric power station

constructed by a former telegraph operator Thomas Alba Edison, in 1882 (Energy Policy, 2011).Even though Alessandro Volta was who developed the voltaic pile, and Michael Faraday the one

that create the first electric generation machine Edison brought for the first time, electric power

to the citizens followed by Westinghouse and Tesla after winning the battle of currents

(Alternating current AC and Direct current DC) (ABB, 2014).

Advantages of AC for large extension transmission and thanks to a reliable generation motor

created by Tesla enabled the construction of a hydraulic generation motor in the Niagara Falls.

After that Westinghouse purchased the rights of a steam turbine in England offering to the

factories low cost power. Soon, electrical lighting bulbs became common in households and other

appliances as the iron presented in the Worlds Fair in Chicago.

The energy consumption in United Stated started a change in sources configuration, from 1775

to 1850 the only important energy source was exclusively wood, giving the throne to coal which

became by far the main energy source with an impressive growth given the extensive use for

heating, railroads and at the end of the 19 th century for electricity; finally a nascent oil and


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electrical power source made their appearance in the scheme. (Figure 1: U.S. Primary Energy

Consumption Estimates by Source, 1775-

Source: (US Energy Information Administration (EIA), 2012)

With the beginning of a new century, developed countries initiated with many different realities

in regards of how the previous started. A raising industrial sector leading the development of

countries and the new maturing energy sources pushing very high this growth. US economy turn

out to be the biggest one during this period, a position that hasnt lost since then. We show in

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Figure 2: Largest GDP 1820-1910 in international dollars


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the following chart (Figure 2: Largest GDP 1820-1910 in international dollars how US overpassed

other stronger economies by that time.

Source: (Maddison, 2009), with own adaptations. Peaks appearing in the chart are due to lack ofdata in previous and following years which are in this case set to 0.

3.Becoming an energized, rolling an unstable world.

Leading the young oil industry still new with not much regulations, Rockefeller gained many

enemies in his way. The first setback was the application of the Sherman Antitrust Act (Late 19th

century) that prohibited any king of conglomerate organization which restricted the free trade

within the United States. (United States History, 2014), favorably Standard Oil didnt receivemuch consequences with this one. In 1901 President Roosevelt ordered an investigation which

forced the dissolution of the Standard Oil trust by an Us Supreme Court decision.

Thirty four independent companies resulted from this division some of them became big player

in the business initially called Standard Oil of New Jersey, Standard Oil of New York and Standard

Oil of California became later on Exxon, Mobil and Chevron respectively. At this point Rockefeller

was in the center of the stage, and became a target for newspaper researchers, an undesirable

issue.

During this period oil began to be a miners target, in different places of the American geographypeople were doing efforts to get the appreciated black oil. Particularly in Texas not many people

thought that would have been possible to find, however different efforts were made. It wasnt

until 1901 when the oil prospector captain Anthony Lucas drilled the Spindletop field up to 347

meters discovering the first major oil well in the United States with a peak production of 17.5

million barrels in 1902. The Texas Company, later Texaco emerged in those fields (Texas State

Historical Association, 2014). Oil exploration and findings expanded all over United States

highlighting the west states of the Mississippi River.

In Europe Industry was developing at the same time but in a different rhythm. One of the first

companies related with petroleum was the Shell Transport from England, initially dedicated tostandard shipping and then in oil transporter. They were importing the product from Borneo,

Russia and Japan and were the first to use the Suez Canal for oil transportation giving them and

special advantage against the big American regarding the Asian market; Rockefeller made an

offer for buying the company but it was rejected. Shell made also an agreement with Dutch Royal

Petroleum Company setting operations in Netherlands, Russia and the region of Azerbaijan which

converted the company in the provider of 75% of the oil outside US. . Another important


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company in Europe was Branobel in the Caucasus region, that later disappeared after the Russian

Revolution intervention. (LESCAROUX & RECH, 2013)

By 1938 the United States produced 21 trillion barrels of oil (4.900 quadrillions of BtuFigure 3

scale) times more than the Soviet Union (the first producer by 1900) and 64% of worlds oil

consumption. In spite of this amazing growth, coal was still the first energy source in the UnitedState, at this point supported by the use in electrical generation; also huge spreading technology.

Around 1950 the lines of oil and coal crossed each others leaving the black liquid to go way

higher over the black solid. Between 1900 and 1920 Samuel J. Schurr and Bruce Netschert

calculated that total energy consumption in United States registered an amazing growth of 123%

(A, 2004)

Source: (Benichou, Rech, & Heyris, 2014). Own database construction

Although the great vision of Rockefeller, I dont believe he imagined back then in 1862 who was

going to be the great driver of his distilled product: the automobile of Henry Ford. In 1903, Ford

Motor Company was founded (Same year of the Wrights Brother first successful airplane) and in

short revolutionized the life of Americans, and the life of all actual livings, through the creation

of an affordable motorized vehicle, capable of transporting individuals as they pleased. The

advances in technologies after the combustion engine were very rapid, one of his first

achievements was the launching of a moving assembly line in 2014 that allowed to build a car

(The model T chassis) in 1 hour 33 minutes, something incredible for almost everybody. By 1920

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Figure 3: Main oil producer countries 1900-1950 in Mbtu


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United States possessed 50% of total world existing automobiles, 60% of them were ford. (Energy

Policy, 2011)

The industry diversified itself rapidly, creating tractors, farm vehicles, trucks and other adapted

vehicles as. Almost all engines were using the distilled product, and since the fever for cars

steadily soared, oil companies were also skyrocketing. From 180.000 passenger cars sold it in1910 the industry reached an amazing 4.500.000 of cars sells in 1929. Winston Churchill

demanded for the construction of one of first armored vehicle, the tank for introducing it in war.

Airplane, and specially ships were designed for using oil as propulsion energy instead of coal.

Churchill needed to develop a trustful fleet, and intended to buy Shell and end it up buying a new

oil company operating in Iran, called the Anglo-Persian Company that was going to be name

changed for British Petroleum the actual BP. World War was also influenced by the power of oil

in any kind of earth, air or water vehicle becoming and sensible supply for strategy decisions.

Churchill said in 1913: If we cannot get oil, we cannot get corn, we cannot get cotton and we

cannot get a thousand and one commodities necessary for [...] Great Britain and the an

American president in 1924: Calvin Coolidge in 1924, the supremacy of nations may be

determined by the possession of available petroleum and its products. (LESCAROUX & RECH,

2013)

The important role oil played for geopolitical matters, plus the reduction in soviet production

pushed up the price of the black gold, going from $0.8/b in 1914 to $3.1/b in 1920. But suddenly

the development of Middle East deposits, conducted to a global overproduction making the two

major players (Standard Oil and Shell) to fight fiercely in prices moving back the global oil price

to $1.2/b. Prices soon stabilized. In 1952 and investigation revealed that an agreement made bythose big companies was the cause of the quick price stabilization in 1935. They agree each other

to work together for making the highest profit possible avoiding the competence in the market.

(LESCAROUX & RECH, 2013). The US government in response to these kind of fixing, imposed the

oil price from extraction in the Gulf of Mexico as the international price, they could do it because

they managed the biggest part of the industry and the consumption.

From 1940, when oil exceeded coal as main energy source the industry became a huge global

market controlled by few companies all of them coming from the powerful economies of that

time (Great Britain, France and United States). In fact, just 7 companies in the world were

managing a great part of world economy The Seven Sisters: The Anglo-Persian Oil Company (BP),Gulf Oil, Standard Oil of California (SoCal) and Texaco (Chevron), Royal Dutch Shell, Standard Oil

of New Jersey (Esso) and Standard Oil Company of New York (Socony) (ExxonMobil) all of them

signatories of the Red Line Agreement (US Department of State, 2014) stating that none of them

will pursue oil interest on the Middle East for not fighting for a market advantage between

themselves risking the loose their position, and this represented the first cartel of oil also known

as the The Consortium of Iran; thecontrolled 85% of world oil reserves.


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As oil became the driver of world economy, price rate became a one of the most important

economical index in the world. We can see inFigure 4: Crude oil prices 1861-2012. USD/barrelthe

price index timeline from 1861 to 2012. Current prices are similar to those from the beginning of

the oil market and oil prices around 1980. In the beginning the product was sold in little volumes,

but since it started to become a mass production product its prices lowered in a great way, until

the mentioned peak in the 80s and now. From this point well use this series as the timeline

reference.

Source: (BP, 2013)

Aware of the strategic role of oil, the constant dilemma of scarcity or abundance begun and so a

variety of product composition and technologies for extraction and production. Thermal cracking

technology was introduced around 1913 developed William Burton and Robert Humphreys

working for Standard Oil (Greatest Achievements, 2014), waterflooding techniques for boosting

oil recovery, blends as the ethanol-gasoline in 1922, German technology of liquefaction and also

the discovery of shale gas which was abandoned because it wasnt necessary at that time because

the boom of other fields. Offshore extraction initiated in 1946. Moreover the creation of the

petrochemical industry increased the uses of petroleum.

Imports of oil before 1945 were almost null, and the internal demand was growing very fast (80%

approximately) especially in gasoline for cars which represented the main consumption product.

The discovery of oil in other parts of the world made the price go down and cheaper petroleum

was available (Kuwait, Iran, Saudi Arabia, Mexico, Venezuela) for American consumers leading to

an increase in imports up to 12% in 1950. For benefiting the oil produced abroad in the United

States Market, the Internal Revenue Service approved the elimination of several taxes which

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Figure 4: Crude oil prices 1861-2012. USD/barrel


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augmented the pumping from Middle Eastern countries. Importing was becoming more usual

and when US became a net importer around 1950, the government of President Dwight

Eisenhower responded imposing quotas for imports. (Energy Policy, 2011).

The first half of the 19thcentury led a world with a spreading oil industry with many countries

developing its tremendous reserves, although they werent exactly aware of how much it was

going to be. A high development on technology for the industry, at the same time they were

building facilities around the world. Stable price, a global oligopoly and a strategic game set

economy players.

United States was now oil dependent country.


4.

Big bang of oil industry and markets

In 1950 United States was by much the most oil industry developed country, and now a

dependent of it Figure 5: Primary Energy Consumption Estimates by Source, 1900-2012

(continuation). Nevertheless the establishment around the world was coming with the

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Figure 5: Primary Energy Consumption Estimates by Source, 1900-2012 (continuation)


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construction of more than 200 new refineries and with shipment of more than 1.750 tankers,

each one with more capacity than the other. Cars were the engine for this high consumption of

gasoline with 2.5 billion of them in the world (Parra, 2009), but now was sharing the pie with

merchandise ships, airplanes and other type pf motorizes vehicles. In Europe and Japan oil also

overtook coal position, in total 11 millions of barrels per day were being consumed in the world.

The end of WWII, the reorganization of the economic system with the end of gold age and the

souring of the black one, the black gold. The vast discovery of reserves, the technology for

extraction and production and the transportation system were in place to offer cheap oil around

the globe. Traffic and CO2 emissions were not a concern

The business was still being ran by the same few major firms. States started to become aware of

the companys revenues and were asking for increase in their profits. Concessions were the type

of agreements that these firms used for exploiting international reserves. They created holdings

associated with the state and always another company of the major was in the associations for

making and interlinked corporation1.

Some little companies were beginning to participate in the market, at first just in a very limited

way. The Italian state owned ENI was offering better financial terms in the concessions thereby

winning some oil concessions; others independents followed these methods. The research for

this new gold brought another reserve countries as Libya and independent American companies

gained participation here, where changes in the setting price were held. Soviet Union countries

were also entering in the market and for doing it they needed to offer interesting discounts, so

different prices were being placed and with it the first signs of competence in the market. In the

Libya, they asked for calculating their profits with respect to the price market, and not the usualfixed price.

The new firms took advantage of the growing market. In 1950 the seven sisters share outside

Canada, USA, URSS and China was 85% in 1950 and ten years later 72%. In the refinery industry

they passes from 72% to 53% in the same period (Chalabi, 2004).

1Each of these companies was a shareholder in other countries in the Middle East. For example, BP owned half of the Kuwait Oil Company andall the oil of pre-Musadeq Iran (although its holding was reduced to 40% in the consortium that was founded after Musadeq) as well as shares inQatar Petroleum Company and Abu Dhabi Petroleum Company, whereas the American company Esso (Exxon) had 30% of Aramco in Saudi Arabiaas well as shares in Qatar Petroleum, Abu Dhabi Petroleum, and the like. This type of interlinking enabled them to control and manage crude oilsupplies worldwide, along with the bulk of oil exports from the major oil-producing countries, so that oil trading became a question ofintercompany exchange with no free market operating outside the companies to control whereby crude oil was exchanged between sellers andother buyers. At the same time, each of these sisters had its own downstream operations transportation, refining, oil products, anddistribution networksthat made them vertically integrated. This compact system of horizontal and vertical integration allowed the companiesto plan for their future crude oil requirements in line with their downstream requirements, that is, the amount of oil products needed by eachaccording to its market outlets in the countries to which crude oil was shipped. (Chalabi, 2004)


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This market openness coincided with global efforts, especially countries involved in WWII, to

make an economic system of cooperation which was pushed strongly by the American expanding

policy of free markets around, and later on the end of the Bretton Woods system.

The American economy was changing too, since they were a world exporter power before 1950

from that time on the supply balance changed directions becoming an economy depending on

imports of goods and services. InFigure 6: U.S. Trade in Goods (not services) as % of GDP - Balance

of Payments (BOP) Basis 1900-2012we can observe the evolution of the goods trade balance from

1900 to 2012 highlighting the fact that 1943 was the last high point from a decrease that has held

ever since in negative state.

Source: (United States Census Bureau, 2014), (UN, 2014)2 (ECON DATA US, 2014), own data

comparison and database construction

During the decade of 50s several European colonies were gaining independence in the Middle

East and North Africa. Moreover, these political issues were occurring in oil producer nations

which were imposing nationalism shift starting with Iraq overthrowing the monarchy in 1958,

Algeria became independent in 1963 and Libya in 1967, where oil was used as a political weapon

2This publication is only available as a draft paper and it is indicated that The data contai ned in the present paper should be regarded aspreliminary, it is requested that no use be made of them until final publication. Yet, the paper appears to be based on solid research and it is thebest source for historical data available to us. Nevertheless this information is provided without assuming any responsibility for the accuracy ofthe data and only as a special service to interested users which can use this data under their own responsibility and according to their ownjudgment.

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.0%

.0%

1900

1903

1906

1909

1912

1915

1918

1921

1924

1927

1930

1933

1936

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2 0 0 8

Balance goods trade % of GDP

Fi ure 6: U.S. Trade in Goods not services as % o GDP - Balance o Pa ments BOP Basis 1900-2012


17/34

(Six day war). These new nations were among the fifty three countries that were producing

around 20 million of barrels of oil per day (1960), just 17 of them almost 100%.

Under this context, of political changes,

oil market configuration and loweringprices (Figure 4), on September 1960

delegates from 5 major oil producing

countries (Iran, Kuwait, Saudi Arabia,

Venezuela, and Iraq) gathered on

Baghdad founded the Organization of

Petroleum Exporters Countries (OPEC).

The purpose was OPEC's objective is to

coordinate and unify petroleum policies

among Member Countries, in order tosecure fair and stable prices for

petroleum producers. Some experts

argue that the trigger for the OPECs

conformation was two successive price

cuts imposed by the 7 sisters, the first

one a 10% cut and the second of 7%

(Chalabi, 2004). Actually the main prime

objective was to safeguard their member

countries' oil revenue against any further

erosion as a result of the companies'deciding to cut prices further.

Source: (Benichou, Rech, & Heyris, 2014)

4.1.OPECs role

Such power of the seven sisters didnt

allow to think that the OPEC was going to

play a major role some years later. In fact

at that time they werent capable of

accomplishing its creations objective.

After the 5 founders, soon were added to

the list Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, and

Country Mbbl/d Percentage

United States of America 6,814.84 33%

Venezuela 2,924.96 14%

Russian Federation & U.S.S.R. 2,895.58 14%

Kuwait 1,661.16 8%

Saudi Arabia 1,263.60 6%

Iran (Islamic Republic of) 1,047.58 5%

Iraq 929.48 5%

Canada 499.41 2%

Indonesia 407.36 2%

Mexico 271.83 1%

Romania 225.22 1%

Argentina 178.81 1%

Algeria 169.01 1%

Qatar 160.79 1%

Colombia 148.45 1%

Trinidad and Tobago 117.31 1%

Germany 108.30 1%

Other 36 countries 784.56 4%

Table 1: Top oil producers by 1960


18/34

Gabon (Ecuador and Gabon quitted around the 90s). With this enlargement started to

gain stage for negotiation with the 7 majors.

Some gained steps began to come, as they implemented unification in tax systems based

on price market rates, which made the new entrants to pay higher taxes than they did

before. They imposed a rule already established in US, where companies had to paid

royalties to the oil land owners regardless profits were realized or not. Chalabi (2004)

argues that some of this taxations measures not only help OPEC to stop prices cuts but

also to strengthen the price structure and the end to expansion of competitive markets

having an effect of maintaining major companies power and reducing chances to new

entrants, which were part of the cause of price instability. Viewing now, this picture then

OPEC pursued price stability not imagining how high prices could have gone. ($120/barrel

2011)

Prices did not go back to the price rates they had before the cuts but member countrieswere amending some contractual holes of disadvantages they had in the concessions.

Prior to OPEC, host countries were not partners in their own industry and their role did

not exceed the levying of taxes from the oil companies (Chalabi, 2004). Moreover, in

1966 OPEC signed a statement, giving its country members the right to set prices

unilaterally in order to give states a major role in the development of the industry; a right

that any other single market product have but oil. (Fair agreements imposed by the

developing companies?).

The first 10 years of OPECs existence helped to improve the state role balance and their

relationship with the big companies, at least in moderated level, until this point servingboth interests. OPEC state members passed from being tax collectors, to prices defining

actors.

Now in 1970, the ambiance changed, member states after achieving a stability of prices

started a series of negotiations with the companies with the intentions of raising the

prices and increasing taxes. It was supposed to be revised every 5 years but with USD

devaluations, they were adjusted after 1972 and 1973. Inflation was also considered in

the price so that their currencies were able to maintain its value. With these measures

price remained stable until June of 1973.

The Tehran signed agreement was based on fixed posted price, but the market price had

reached very high levels and OPECs manifested that the price differential should be

share between the associates. The big majors refused to accept a change on the

agreement and four month later they applied the statement that dictated the power to

set the price unilaterally and they announced an increase of 70% passing from

$3.2/barrel to $5.4.


19/34

This decision occurred at the same period of war between the allies Syria-Egypt against

Israel. United States and Netherlands decided to defend Israel fact that triggered a politic

reaction against using oil as a weapon that lead to a decision of placing an oil embargo

to the United States of America. An unexpected consequence resulted from this, not by

the effect but because of the level, when oil prices soared in a striking way.

Market prices reaches $15/barrel and OPEC members did so in a more moderated way

led by the Iranian position of raising prices substantially in this case up to $10.84/barrel.

The effects were very wide from consumption reduction policies, increase in gasoline for

car prices reaching the end consumer becoming a very high product. In the other hand,

sales volumes reduced dramatically reducing states incomes in the same level. Europe

decreased 8% of its consumption, way more than Japan and USA that had less taxed oil

end use products. Just few years later people got quickly used to high prices, retaking

their normal consumption rhythms. In 1970 another shock in prices due the Iranianrevolution pulled again the oil price because the offer reduction.

OPEC, acting rationally, sat some temporally additional cost to the price given this,

considered unusual, situation but market prices kept ricing and the additional cost

remained inside. In 1979 in the Caracas meeting, prices had reached $24/barrel and a

year later $36/barrel. The world started to understand that this situation was becoming

steady so the awareness of the need of changing such dependence arise. The

development of new providers, new energy sources, low consumption technologies and

habits was the result, not that much yet for end users, as the world was still growing very

fast in a high international investment context and global trade.

Figure 7: World and U.S. oil consumption. In another scale oil prices (1965-2012) (Thousand barrels daily, $)


20/34


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prices, so they were being unable to sustain the payback of investments. Finally they had

to readopt the quota system and price reached an $18/barrel

By 1987 the system was updated setting a scheme of pricing made by a basket of oil from

member productions and then abandoning the fixed price model to a system where they

were adapting the price to a target. This brought also the differentiation of oil prices inregards of its quality and transportation costs, bringing also a global agreement of how

things were running, lowering discussions and pressures among OPEC members although

they were now not following its creation objective of price stability.

From this point the price and production have been ruled almost by a similar system now

a global commodity, the largest single one, which was responding to global economy

behavior and highly immersed in the geopolitical game. As Chalabi (2004) recalls the high

volatility of prices around this period was coming from political instability: the first shock

in 1973 because of Arab Oil Embargo, the second by the Iranian Revolution in 1979, the

Iraqi invasion of Kuwait in 1990. Until the XXI century were similar scenarios but with a

constant raise in prices has been the dynamic; well see later on the recent movements.

5.An oiled trade balance?

In a growing trade world, especially in fuels and mining products, (Figure 8,excludes automotive

products and manufacturers) oil was becoming the single most traded commodity in the world,(by value) and of course United States, the largest economy in the world, the first consumer of

oil in spite of being one of the three main producers.


22/34

Source: (World Trade Organisation, 2013)

Forty percent of US energy consumption is in oil and for transportation 97% comes from it

(Securing America's Future Energy, 2006). Its clear dependency has classified the energy supply

a matter of National Security and its management is maybe the most strategic process in for the

American government.

The use of this vast amount of energy is an empirical evidence for all modern growth theory

which assumes that GDP growth per capita is driven by technological process and capital

investment, an update from the standard theory of capital and labour, bringing the concept of

technology-enhanced labour productivity (Robert, Jeroen, Dietmar, & Benjamin, 2013). Its very

important to highlight that energy is not just the consumption as a driver of the economy, but

its even more important understanding the role that energy plays in the industry, services and

by the economic importance of energy itself as a huge industry.

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

1980

1981

1982

1983

1984

1985

1986

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1988

1989

1990

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1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

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2005

2006

2007

2008

2009

2010

2011

2 0 1 2

x10000

0000

Fuels Fuels and mining productsAgricultural products ChemicalsClothing Electronic data processing and office equipmentFood Integrated circuits and electronic componentsIron and steel Office and telecom equipmentPharmaceuticals Telecommunications equipment

Figure 8: World commodity trades by group of products (1980-2012) ($)


23/34

Thus, even though energy efficiency has improved lowering the energy intensity (Energy

use/GDP) the US economy curve owes great part of its growing rhythm to the curve of energy

consumption-production.Figure 9.

Source: (World Bank, 2013), (US Energy Information Administration (EIA), 2012)

Nonetheless, US economy have been dealing with a competitive loss, since their products being

exported area a lot less than what theyre importing and the amount that exported services

added for a while is reduced compared to what they need as economy. This has been impactingthe debated American deficit and how the economy can prevail with such unbalances. Recent

financial and real state crisis increased the concern about this issue.

The relationship between energy (oil) and the deficit is that the trade unbalanced is produced

mainly because the huge amount of oil US needs for running its economy that multiplied by a

steadily international market oil price flying over the border of $100/barrel since long time with

not expectation of a downturn in its value for the coming years. In this sense, the problem of

deficit is that for keeping the same economy levels you need to finance the deficit with debt and

this means you have to pay interest making final prices higher for Americans. Even more complex

is that if you keep increasing your debt, and you dont have the means for generating surplus youwont be able to pay the debt in an hypothetical case that your dont find more acceptable

borrowing. So, what would happen if prices keeps its accelerating rhythm in the following years?

Since 2004 the United States trade balance deficit started to increase in an extraordinary way

changing for example from 2003 to 2004 in more than 23% reaching a peak of $752 billion in

2005. The slow down on the economic activity made return the deficit to a lower state in 2009

-

500.0

1000

1500

2000

2500

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

GDP current US$ Mil lion Primary Energy: Consumption (MTOE)

Figure 9: US GDP and energy consumption (1965-2012)


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but at first sign of recovery the tendency was regained with an increase of 43% from 2009 to

2011 registering a value of $556 billion by that year (Figure 10).

Source: (United States Census Bureau, 2014)

We can observe how since 1982 when oil prices start to play in the market game, US trade

balance became negative recovering the trend in 1990 and just 2 years after the negative line

went far away from 0 and has come back ever since, not even close. Services balance has helped

to reduce the gap in the goods export/import balance but is still litle. By 2008 18% of US imports

were in petroleum products and represented 65% of the US deficit, heading 2012 $414 billion

were spent on petroleum, 15% of US imports and 78% of US deficit. (United States Census

Bureau, 2014) (US Department of Commerce, 2013)

The price raise of oil strongly affects US economy through the extended bill for importing fuel

that directly hit the trade balance and its deficit. As prices increases the relationship between the

deficit and prices become augments, using the oil data and deficit report we can standardized

those time series variables for observing the fluctuations between them. In this exercise I want

to show if there is a correlation between them and we find the following chart. Since 2000 thelines crossed each others and their movements have similar patterns we can infer an association

-1,000,000

-800,000

-600,000

-400,000

-200,000

0

200,000

400,000

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Goods BOP Services Balance

Figure 10: U.S. Trade in Goods and Services - Balance of Payments (BOP) Basis $US (1960-2012)


25/34

in both series as we have argued before that great part of US economy depend on oil prices and

fuel imports.

Source: (United States Census Bureau, 2014), (US Department of Commerce, 2013), own creation

Having shown with all the indicator measures and the analysis of data, we can notice the

influence that oil have in US economy from 1950 to this point, and having seen all trends we can

expect that its energetic environment and consumption patterns are going to stay alike for manymore years. The question arising is how is the United States government going to control the big

topic of the deficit and how the National Security strategic game is going to run for guaranteeing

stabilization in the economy. We wont address all the measures and policies the US cabinet can

deploy, however were going to aboard an interesting maturing oil production which is starting

to invert the oil import trends in US and that despite critics and skepticism is showing some real

and strong signs; the shale oil and gas.

In the following subsection it is presented an analysis about the sustainability of the current trade

unbalanced, the current US debt and possible scenarios for the nominal interest rate.

5.1.Exterior deficit analysis

Based on an exercise published by Fernandez (2007) evaluating the sustainability of US

foreign deficit I projected different scenarios that US may face keeping actual and similar

variables in its economy.

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

Standardized oil prices Standardized Surplus/Deficit

Figure 11: Correlation patterns between oil prices and the US surplus/deficit


26/34

Source: (Fernndez, 2007)

We came up with this results using actual values (Fernandez were until 2006), where we havefrom one side (left) different scenarios up and down from US current nominal interest rate,

and in other side (top) different trade unbalanced percentage also centered on current values

and projecting values up and down from it. The results extrapolate the current debt with a

GDP growth rate of 4.7% (ten years back average), the interests and commercial trade

unbalanced explained above.

Source: own calculation and database construction3

3No values are negative debt which is incorrect for the calculation. As the tool created for projecting the debtis adaptable for any country, there is a wider range which in critical cases as the US just focus in central values

(red bars)

1% 2% 3% 4% 5% 6% 7%

0%No No No No No No No

1% 29% 57% 86% 114% 143% 171% 200%

2% 39% 79% 118% 157% 197% 236% 275%

3% 63% 126% 189% 252% 315% 378% 441%

4% 158% 316% 474% 632% 790% 948% 1106%

5%No No No No No No No

Commercial dficit (GDP %)

Nominalinterestrate

Model of level of debt:

=1+

D=debt level in year t

i= nominal interest rate

X=Sum of deficit

g= nominal growth rate

Y=GDP

Equation 1: Debt level projection

Table 2: US debt level projection with a growth rate of 4.7%


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As it is shown inTable 2: US debt level projection with a growth rate of 4.7%an economy with

current US indicators and keeping the commercial unbalanced will be unsustainable in medium

and long term.

6.Fracking the economy

Its very common to hear nowadays about the shale gas (or shale oil) especially if youre in the

industry, for those who dont, shale gas or oil is the same product that we have recovered for

many years but this one is found below the common layer and is trapped in a shale which is

formed by fine-grain sedimentary rock; its like a hard rockbeing before the oil in the ground

layers. The fun think about this, is that the shale is too complicated to pass in regular drilling

technics, so a special process is been developing allowing to break the shale and obtain the

precious shale energy; with a very controversial and expensive process known as fracking.

As we mentioned in section3,this type of oil is not new, it was discovered long time before but

thanks to abundant reserves in less deep deposits, and given the prices back then, the recoverywasnt economically feasible. Conditions has changed, although world reserves are still huge , the

easier extracted kind are becoming less and less, so scarcity concerns has arisen in many different

reports and studies; and its easy to understand what happen if countries think that youre

running out of oil. In US geography oil is not enough, or at least the common reserves werent

enough, and being the first consumer of the world, the main importer, a country with a high trade

balance deficit and always political risks any investment aiming to soften this scenario worth to

risk.

We wont go further talking about the technical matters of shale fuels and the fracking, just a

summary of what is in discussion will be presented. The focus then, will be to show the current

US oil supply and to draw a scenario where shale gas become a great volume source of energy

enabling to reduce US commodities expenses weather by reducing imports or even enhancing

the trade unbalance by exporting shale oil and gas. The big hole we have seen in previous charts,

and then the deficit could change and clean its face. Just few things about fracking

Shale gas an oil are the same product as the one we have used since its discovery

Its actually obtained using a fracking method

Fracking methods exist since 1930 approximately

A recent advance on the technology, created the horizontal fracturing that makesthe process economically reasonable

Horizontal fracking is been highly controversial, mainly arguing that the use of

chemical processes contaminates water sources.

Recent research have been made in order to prove or disapprove the findings of

chemical products in the water. Some have been found, none has been sufficiently

powerful to revert its use or to increase the opposition campaign against it.


28/34

In France an UK has been a recent big debate, the first one officially disapprove

the use of it, the second is already approved and oil 7 gas companies are already

in place

This picture is making now a real impact, given that the technology was placed several years ago

and were actually starting to feel the influence of this important development. We can see inchartFigure 12 the evolution of US production and imports where we can noticed that around

1995 imports became the main supply source but especially we want to focus in the reduction of

imports and the growth on production shown in the last 4 years. Are they going to become closer

or its a temporally effect due to crisis and high prices? Or are they going to crossed each other

bringing benefits to the America economy?


The big part of shale oil is being recovered as gas, we can seeFigure 13 that the difference in

increasing total volume is been given by Shale gas sources, it worth to mention that tight gas is

also recovered using fracking similar procedures. From a total of 8.3 trillion ft in 2012 added by

shale gas EIA estimates that will be the double for 2040. With this figures oil should growth to

9.6 million of barrels per day, reaching US record in 1970 (Financial Times, 2014). In the samereport the EIA director said that the share of US oil liquid consumption was 60% from the total in

2005 and should decrease to just 24% in 2015. With this results the oil & gas industry received

the approval for initiating exports of liquefied natural gas (LNG) summing to the positive side of

the trade balance (LNG price could be between 5-8 times less than oil prices)

0

2000

4000

6000

8000

10000

12000

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1904

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1912

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1932

1936

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1944

1948

1952

1956

1960

1964

1968

1972

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1980

1984

1988

1992

1996

2000

2004

2008

2012

U.S. Field Production of Crude Oil (Thousand Barrels per Day) U.S. Imports of Crude Oil (Thousand Barrels per Day)

Figure 12: US oil imports and production (1910-2012)


29/34


Last November (11/2013), The US Commerce

Department informed of a drop in the US

deficit to $34 billion almost an 8% thanks to

the drop in oil imports in total the first 11

month of 2013 US saved around $40 billionraising US economic GDP expectations to

growth by 3.5%. (Forbes, 2014). Its risky to

make projections of what would happen with

this US energy balance improvement will lead

to, but its clear that is significant helping to

overcome US economic deficit. What is sure

is more changes will come, because US

reducing its dependence of oil imports and

becoming an energy exporter will surely

affect global energy prices and also thegeopolitical game. As American say time flies

like an arrow, I believe that by the following

years or month we should keep track of what

shale fuel and US energy will bring us,

because it could play an important role again

in global economy. Highlighting that who holds the biggest shale gas recoverable reserves so far.

0.00

5.00

10.00

15.00

20.00

25.00

30.00

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20

Non-associated onshore Associated with oi l Coalbed methane Non-associated offshore Alaska Tight gas Shale gas

Figure 13: Natural gas production by category (1990-2012) in trillion cubic feet per year

19%

14%

12%

12%

10%

9%

8%

7%5%

4%

China Argentina Algeria U.S.1Canada Mexico Australia South Africa

Russia Brazil

Figure 14: Top 10 countries with technically recoverable

shale gas resources (%)



30/34

7.Conclusions

Were all sure that energy will remain a fundamental part of our living, we know that oil wont

last forever and that by end of this century we will have less oil & gas fuels than we had in 1900.Technology in exploration, extraction, distribution, consumption will play a big role for extending

actual reserves and developing alternative sources, as the shale fuel who will certainly add

volume to the equation, not only because of the power it could generate but because is starting

to push hard in recovery and strengthening the American economy. The controversial subject of

US trade balance and their deficit could add another section of global debate.

Other big and medium countries with shale reserves, yet not that developed in facilities and

techniques, will influence in positioning their economies in the field. Oil will keep us managing

and discussing around him, we may start to think after it.


31/34

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Illustration list

Figure 1: U.S. Primary Energy Consumption Estimates by Source, 1775-1910 .............................. 8

Figure 2: Largest GDP 1820-1910 in international dollars .............................................................. 8

Figure 3: Main oil producer countries 1900-1950 in Mbtu .......................................................... 10

Figure 4: Crude oil prices 1861-2012. USD/barrel ........................................................................ 12

Figure 5: Primary Energy Consumption Estimates by Source, 1900-2012 (continuation) ........... 13

Figure 6: U.S. Trade in Goods (not services) as % of GDP - Balance of Payments (BOP) Basis 1900-

2012 .............................................................................................................................................. 15

Figure 7: World and U.S. oil consumption. In another scale oil prices (1965-2012) (Thousand

barrels daily, $).............................................................................................................................. 18

Figure 8: World commodity trades by group of products (1980-2012) ($) .................................. 21

Figure 9: US GDP and energy consumption (1965-2012) ............................................................. 22

Figure 10: U.S. Trade in Goods and Services - Balance of Payments (BOP) Basis $US (1960-2012)

....................................................................................................................................................... 23

Figure 11: Correlation patterns between oil prices and the US surplus/deficit ........................... 24

Figure 12: US oil imports and production (1910-2012) ................................................................ 27

Figure 13: Natural gas production by category (1990-2012) in trillion cubic feet per year ......... 28

Figure 14: Top 10 countries with technically recoverable shale gas resources (%) ..................... 28

Table 1: Top oil producers by 1960............................................................................................... 16

Table 2: US debt level projection with a growth rate of 4.7% ...................................................... 25
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