Shales, the US Trade Deficit, and Dollar Appreciation

Why is the US dollar so strong?  This is a complicated question, but we have reason to believe that US shale production growth may be a principal driver of dollar appreciation.

In the 1990s, US oil imports (defined here as net crude oil imports minus net refined product exports) averaged less than 1% of GDP.  Indeed, when oil prices collapsed in 1998, net imports bottomed at only 0.5% of GDP.  After that, however, imports as a share of GDP continued to rise.  From 2000 to 2007, oil imports soared to 2.7% of GDP, culminating in the Great Recession of 2008.  With the recession, US oil consumption and oil prices collapsed, and oil imports fell back to a more manageable--but still historically high--percent of GDP.

After the trough of the recession, oil prices began a quick recovery, spiking with the Arab Spring of 2011.  This sent Europe into a three year recession.  By contrast, the US escaped with mere 'secular stagnation.'  Why? 

Shale oil production saved the day.  Shale oil began to materially affect the US economy in 2011, as US oil increasingly displaced imports.  From 2011 through 2014, oil imports were falling by more than 1 mbpd / year, reducing the import burden by 0.4% of GDP per year.   Until 2014, this was achieved essentially through increases in US oil production, as oil prices remained stubbornly high. 

By the second half of 2014, however, not only was US production soaring, oil prices were plummeting.  As a result, in 2015 alone, the import burden will have fallen by 0.6% (percentage points) of GDP.   Thus, US oil imports fell from a peak of 2.7% of GDP in 2005, to a mere 0.5% in 2015, the lowest since the Asian Financial Crisis of 1998. 

Source: EIA, IMF, Prienga estimates

Source: EIA, IMF, Prienga estimates

But how much of this is due to US shale oil production?  As it turns out, we can estimate this number.

Had the US not increased its output with shale, the country would have had to import the increment, a difference of around 4 mbpd in 2015.  Further, without shales, oil prices would have likely remained in the range which prevailed during 2011 - July 2014, that is, around $110 / barrel on a Brent basis.

In such an event, US imports would still have declined, in part due to decreased consumption and in part due to increased production in the US Gulf of Mexico.  But imports would have remained quite high by historical standards, above 1.7% of GDP and a percentage point more than in the 1990s.

What would have happened to the economy in such an event?  Europe and Japan provide some insight.  Europe was in recession from 2011 to 2013 and Japan has struggled on and off to get its economy out of the doldrums.  Without shale production, US 'secular stagnation' would probably have looked more like a prolonged recession, as the country struggled to reduce its oil import bills by increasing efficiency.  Due to surging shale oil production, however, the US escaped the need to drastically curtail oil consumption, and the country rebalanced its current account with simple import substitution.  Oil saved the day.

We can also look at this in dollar terms.  In 2008, the US spent nearly $400 bn (in 2008 dollars) importing oil.  In 2015, this bill will have fallen to a mere $90 billion, a drop of more than three-quarters.  This year alone, shale production will have saved the US $250 bn in oil imports, reducing the trade deficit by an impressive $20 bn per month.  Is it a surprise that the dollar should be strong?

Source: EIA, IMF, Prienga estimates

Source: EIA, IMF, Prienga estimates

Nevertheless, the story ends on a cautionary note.  US oil production is falling and is likely to be lower in 2016 than in 2015.  Moreover, US oil consumption is rising quickly, up about 3% so far this year.  And finally, oil prices are likely to rise, possibly quite substantially.  Thus, the US in 2015 will probably see its lowest oil import bill for the next several years. 

How things turn out in the long run depends intrinsically on the path of US shale oil production.  Markets will correct and oil prices will recover.  If US shale fulfills its promise, then shale oil growth will return, and US oil imports may once again begin to fall.  Conceivably, the US could become an oil exporter.  In such a case, the oil trade deficit could once again begin to fall.  Indeed, the deficit could become a surplus.

But more likely, if US shales perform reasonably well, the US oil trade deficit will stabilize at a fairly low level, below 1% of GDP.   The US will remain a modest oil importer, and oil prices will stabilize at a higher level, but well below $100 / barrel.  The US oil import bill will look manageable, much as it did during the go-go days of the 1990s.   It's not everything, but still a pretty good outcome.