ISIS, Oil, and the Economy

For now it looks as though increased domestic oil and gas production has saved the recovery. Were it not for this impressive rise in output, the current mess in Iraq and Syria would likely have driven global oil prices up to $130-140 a barrel, a level that could easily have stalled this country’s already weak economic recovery. Of course, these troubles are just beginning. If they gain enough sufficient momentum to threaten as yet undisturbed oil flows through the Persian Gulf, North American production would fail to fill the gap, the price of a barrel would rise, and the world’s economic prospects would dim.

The relief to date from new production has little to do with Washington’s pointless obsession with “energy independence.” One way or another, everyone, even the biggest oil exporter, pays the global price. The relief in the present circumstance grows not from independence but from the significant difference U.S. and Canadian oil production has made in global supplies. Specifically, the 20.4 percent increase in Canadian oil production since 2011 and 41.9 percent increase in U.S. production, as reported by the Energy Information Administration (EIA), have more than offset declines in Mexican and the North Sea output and pushed up global supply flows by 2,492 thousand barrels a day during this time.

There is another, more important element in this equation. The technologies that have permitted this surge in North American production also promise still more such growth in the future, particularly in more reliable places than the Middle East. Already, according to the EIA, U.S. production is more than a third the size of the entire Persian Gulf region, which includes Saudi Arabia, Kuwaiti, Iraq, Iran, the United Arab Emirates, and lesser suppliers, such as Bahrain and Qatar. It is not just North America, either. Australian sources announced not too long ago a huge shale find that, if preliminary reports are to be believed, could increase global oil and gas supplies some 13 percent. Coming years should also see production form Brazil’s large conventional oil find in the South Atlantic and the promising exploration Exxon is now doing in the Russian artic. Though these future sources will take time to develop, oil prices, just like those in every financial and commodity market, reflect prospects and risks even more than current supply and demand conditions.

Still, there is no mistaking the huge remaining importance of Persian Gulf supplies. If the turmoil there were to take a significant portion of this output off line suddenly, the world would be hard pressed to replace it, and prices would rise with all their ill effects. What is more, the Persian Gulf itself is also a choke point of no small significance in oil transport. The EIA reports that upwards of 35 percent of sea going oil and gas passes through the Gulf and the narrow Strait of Hormuz at its head. If Iran were to become further embroiled in Iraq’s problems or otherwise come to a confrontation with Western powers, the strait would close and the world would find itself without any of this still crucial supply. To be sure, the United States Navy has a major presence in the Gulf, and it claims that it could prevent any such disruption. The navy surely could make good on its promise, but the strait would close anyway, for the still significant threat to shipping would prompt insurers either to refuse to cover cargos in the Gulf or raise premiums to unsupportable levels.

For the time being, markets have stood up well in the situation. Shipments continue even from Iraq and certainly from Kuwaiti, Saudi Arabia, Iran, the Emirates, and other sources, even as the rise of reliable sources outside the region disarms fears of any additional disruption. But given the continued importance of Gulf supplies generally and of the Gulf as a shipping lane, an expansion of this turmoil still threatens to overwhelm the confidence built on Canadian and U.S. supplies, raise oil prices, and, accordingly, impede economic growth.

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