Drilling Downturn Hits U.S. Oil Consumption: Kemp

Oil and gas production was one of the fastest-growing industries in the United States between 2009 and 2014 according to the U.S. Bureau of Economic Analysis (BEA).

Oil production increased by more than 60 percent while natural gas production was up by more than 25 percent thanks to the shale revolution.

What is less well-known is that oil and gas production is also very energy intensive and the drilling boom contributed significantly to fuel consumption, especially diesel.

Now the drilling boom is over, lower fuel demand from oil and gas producers helps explain why diesel consumption in the United States has been unusually weak over the last 12 months.

Fuel consumption by oil and gas producers themselves is an example of what is known in control systems theory as positive feedback.

The more oil and gas the drillers produced, the more fuel they and their suppliers consumed, creating even more demand, and stimulating even more production.

Systems characterised by positive feedback tend to be prone to instability and boom-bust cycles. In the oil and gas sector, positive feedback contributes to the instability of supply, demand and prices.

Fuel consumption by oil and gas producers and their suppliers is not the only example of destabilising positive feedback in oil and gas markets, and may not even be the most important.

Oil and gas lending and the state of the economy are also subject to positive feedback effects which destabilise oil and gas markets.

But the fuel requirements of oil and gas production are significant enough that they are having a noticeable impact on consumption and prices, especially for diesel.

INPUT-OUTPUT ACCOUNTS
In 2014, oil and gas producers required around 10 cents worth of oil and gas production to produce $1 of oil and gas output, according to the BEA ("Commodity-by-industry direct requirements" 2014).

Drilling rigs and hydraulic fracturing pumps mostly employ high-horsepower diesel-electric engines that run 24 hours per day consuming enormous quantities of diesel.

Most of the heating, lighting and other services at remote well sites are also provided by diesel-electric generators.

Fuel consumption is one of the largest operating costs for oil and gas drilling firms, especially when diesel prices are high.

In addition to all this direct demand for oil and gas created by the drilling industry, there is also the indirect demand created by all the other products used by the drilling industry.

For example, fracturing requires sand, which is quarried using trucks and other heavy equipment that run on diesel.

Drilling requires steel drill pipes, which must be produced at steel plants that themselves use diesel and natural gas.

The raw materials for drilling and fracturing arrive at the well site by road and rail on trucks and trains that consume diesel fuel.

Once oil and gas has been produced, it is carried away in trucks, railroad tank cars and pipelines that consume even more diesel and natural gas.

The quarries, steel mills, trucking firms, railroads and pipelines which supply the oil and gas industry all have their own suppliers, which in turn consume diesel, gasoline, natural gas and other petroleum-based fuels.

Oil and gas production therefore has a powerful multiplier effect on both economic activity and fuel consumption.

Producing $1 worth of oil and gas required $1.58 of gross output by all domestic industries in 2014, according to the BEA ("Commodity-by-commodity total requirements" 2014).

Once all the direct and indirect effects are taken into account, U.S. oil and gas producers stimulated $1.12 worth of oil and gas demand for every $1 that they produced in 2014.

Both the direct requirements and total requirements created by drillers themselves are contained in input-output accounts published on the BEA's website (http://www.bea.gov/iTable/index_industry_io.cfm).

During the boom, oil and gas drillers created enormous extra demand for raw materials, transport and workers, all of which in turn stimulated more oil and gas demand. Now the process has gone into reverse, worsening the slump.

By John Kemp