Even though oil and gas commodities are exempt,recently imposed tariffs have caused oil prices to fall to levels not seen since the pandemic.Natural gas prices,usually correlated to oil prices,are following the trend.A looming threat of a recession portends reduced demand for energy.As prices fall to a level where fossil fuel companies cannot make a profit,energy industry executives seem to be pursuing a strategy of“Chill,Baby,Chill.”
Global markets created a platform for U.S.growth
Oil and natural gas are global commodities traded in global markets.The U.S.has increased its market share,with domestic oil and natural gas production and exports reaching all-time highs.In 2018,the U.S.surpassed Saudi Arabia and Russia to become the world’s largest oil producer,reaching a monthly production high in December 2024.Natural gas exports from the U.S.went from zero prior to 2016 to exceeding global supply from any other country in 2023.Fossil fuel production and exports in the United States have been setting record highs in response to market signals;competitive markets,far more than political rhetoric,send the price signals for oil and gas companies to increase or decrease drilling.
Project pipelines respond to market signals
The uptick in production is a direct result of hydraulic fracturing technology,which unlocked previously inaccessible reserves.“Unconventional”drilling dominates oil and gas production and can access confirmed reserves that can provide more than 200 years of natural gas supply to the U.S.It is difficult to believe that twenty years ago,companies were investing in natural gas import facilities to bring liquified natural gas into the U.S.Today,American liquefaction and natural gas export facilities,all of which are less than a decade old,cannot sell enough.As a result,natural gas prices generally have remained at lower levels domestically compared to the rest of the world due to limited liquefaction and export capability.Building out additional liquefaction capacity would allow for greater integration with global markets.However,nearly all of any incremental production would go to international buyers versus domestic users.
Blowouts happen
As U.S.fossil fuel production increased,so did the sensitivity of drilling to price signals.U.S.rig count is highly responsive to market shocks,as is production,as seen during the dramatic demand drop due to Covid and sharp increase in response to supply chain constraints caused by the Ukraine War.Unconventional oil production in the U.S.has an estimated marginal cost to produce of around$40 to$60 per barrel.Oil prices fell below$60 per barrel during the most recent market rout and Goldman Sachs warned that prices could fall below$40 per barrel.In other words,potential economic impacts of the tariffs already are eating into margins for U.S.producers,challenging profitability and putting a damper on new drilling.
Rallying cries mobilize voters,not industry
Although“Drill,Baby,Drill”was an effective rallying cry for American energy independence in the 2024 election,the industry knew the tension that this would create.As reported in The New York Times and elsewhere earlier this year,big oil executives started to voice concerns that excessive drilling would tank market prices.Incumbents benefit from barriers to entry tied to siting and environmental permits,so relaxing regulations could actually harm existing players.Big energy corporations were making their position clear:they would prefer to chill,not drill,unless it was in response to market prices.
Regardless,don’t expect energy independence
Even if drilling were to recover from tariffs and achieve a renaissance,the outcome would not be energy independence.The U.S.produces sweet crude while other parts of the world produce a heavier,sour crude.U.S.refineries generally process sour crude,and it is simply too expensive to convert those refineries to accept a different,lighter,input to production at the current price differentials.As a result,the U.S.will continue to import sour crude as an input to production in their own domestic refineries regardless of how much drilling occurs domestically.
Although record production allowed the U.S.to become a net exporter of oil in 2020,the country has been a net exporter of petroleum products since 2011.A significant investment in new refineries would be required before the country could eliminate reliance on external sources of oil.Such investment currently is not economically rational,especially compared to the more cost-effective and efficient avenues of adopting alternative fuel sources such as electric,natural gas or hydrogen,all of which can be produced domestically.
Similarly,excess natural gas production already has devastated the economics of domestic coal plants and even challenged low-cost nuclear power production as new supply was forced to find its market domestically.With home,business and industrial demand for natural gas relatively fixed but subject to weather conditions,the electricity sector became the swing demand for natural gas.New liquefaction facilities simply offer a new market for domestically-produced natural gas–a global market that serves the rest of the world.
A policy of“drill,baby,drill”creates greater dependence on international markets,not less.
Back in and put-out
As tariffs drive prices for oil and natural gas down to levels below marginal costs of production,expect to see immediate drops in rig count and drilling.Even though natural gas and oil is exempt from the proposed tariff regime,tariffs are chilling the need for new drilling.It turns out that oil and natural gas producers may not want an unlimited political license to drill.Unfettered production can crush oil and natural gas prices.The free-fall in fossil fuel prices runs counter to what a“drill baby drill”policy requires.As prices fall below marginal costs of production,oil and gas companies already are pulling back.
Under Trump’s tariffs,“Chill,Baby,Chill”may be the new response to public policy going forward.
