President Obama has stated that there is nothing that the he can do to influence the price of gasoline. He goes on to say that more domestic drilling and production will have no impact on prices: “You know we can’t just drill our way to lower gas prices. Drill, baby, drill is a “bumper sticker, not a strategy to solve our energy challenge.”
Is it true that crude oil and gasoline prices are exempt from the laws of supply and demand? The simple answer is no. As U. S. crude oil production becomes a more significant component of world oil supplies, the price of crude oil will come down and bring the price of gasoline with it, assuming that increases in demand do not offset it. Domestic production of crude oil and natural gas will continue to increase rapidly as a result of horizontal drilling and hydraulic fracturing, the two technologies that have opened up natural gas and oil-bearing shales, resulting significant structural changes in those markets.
President Obama’s position was supposedly bolstered by the release of a study showing that there is no correlation between the level of domestic crude production and the price of crude. The Associated Press article, entitled “Study finds no link between oil drilling, gas prices,” is a statistical analysis of 36 years of monthly, inflation-adjusted gasoline prices and U.S. domestic oil production. The authors states that they found no statistical correlation between how much oil comes out of U.S. wells and the price at the pump.
Assuming that the authors performed the regression analysis correctly, this observation does not mean that there will never be a relationship between domestic crude oil production and crude oil prices. The correct interpretation is that U.S. crude oil has not been a significant enough component of world crude oil production to have an impact on oil prices.
However, this is changing (economists call this a structural change) due to the combination of two technologies: horizontal drilling and hydraulic fracturing. Beginning in 2009, the proven reserves of crude oil in the U.S. increased for the first time in decades, according to the Energy Information Administration, as a result of the use of these technologies. Most of these increases in production have been on private land as access to public lands has declined in recent years. If the U.S. government would open up more federal lands and offshore areas to drilling, domestic crude oil production would become a more significant component of the world oil supply, and this U.S, produced crude oil production would exert downward pressure on crude prices. As proof, witness domestic natural gas prices, which are seeing levels not experienced since the early 1980’s.
While the connection between crude oil prices and gasoline prices is not one-to-one there is certainly a connection: increases in domestic drilling and production will lower price of the crude and this will translate into lower prices of gasoline, all other things being equal. “Drill baby drill” is in fact the only strategy to solve our energy challenges in the foreseeable future.