The Texas Economy: Economic Impact of a Floor Price for Crude Oil

Transcription

1 Bureau of Business Research College and Graduate School of Business, University of Texas at Austin February 1990 The Texas Economy: Economic Impact of a Floor Price for Crude Oil In a recent policy paper, these authors and other members of a task force suggested that national security could be enhanced significantly by the establishment of a guaranteed minimum domestic price (a "floor" price) for crude oil. 1 Such a floor price, which could be implemented by means of a variable tariff or auctioned import rights, would reduce the uncertainty attending investments in exploration and development of new discoveries and, by raising the average domestic price above the average world price, would stimulate domestic production and motivate both substitution of other domestically produced energy sources and general conservation of energy. All three of these responses would in turn reduce the nation's dependence on insecure foreign sources of oil. We estimated that a floor price of $25 per barrel (in constant dollars of 1989 purchasing power) could stabilize the nation's self-sufficiency in energy at about 85 percent of total energy consumption. Since the Texas economy still depends to a major degree on the oil and gas and related industries, the question arises: What would be the economic effect in the state of an implemented floor price of $25 per barrel for crude oil, adjusted continuously for inflation? The answer is complex, partly because some major Texas industries that depend on oil or gas for inputs of energy or raw materials would be adversely affected by a higher real price and partly because the substitution and conservation responses to a higher real price would limit the growth of national demand for energy. The limitation would be more severe for oil than for gas, however, since gas is a substitute for oil in some important uses. Moreover, the resource base of gas in Texas is richer than that of oil, so gas exploration and production are likely to be stimulated more than oil exploration and production in response to a higher real price of oil. Two other factors would play major roles in determining the effects on the state's economy: technological progress in finding and recovery and steady depletion of the resource base, the former tending to lower the real costs of additional oil or gas production and the latter tending to raise them. In the space available here, it is not possible to examine each of these factors separately; the discussion must be confined to the probable net effect on Texas oil production and related economic activities, as suggested by experience with relatively high prices in the 1970s. Figure 1 shows the relationship of Texas crude oil production to the real (inflation adjusted) price of West Texas Intermediate oil from 1954 through From 1954 to 1970, Texas had substantial amounts of spare producing capacity; so for this period, both actual production and potential production are shown. The potential production plot alone shows almost unrelieved decline after the mid-1960s. As for the real price of oil in Texas, it declined slowly but steadily from 1954 to 1973, then shot up in two stages in the 1970s in association with the world price, strongly influenced by OPEC. Thereafter the decline was steep, dropping to $16.44 per barrel in As of December 1989, the real price of oil in Texas was approximately $18 per barrel in 1986 dollars. With the sharp rise in the real price of oil in the 1970s there was, with a lag of several years, a significant reduction in the rate of decline in Texas production; then, again with a lag, there was an increase in the rate of decline in response to the sharp price reductions after In fact, the rate of decline slowed from 6.0

2 llllll!ll!!:lllll!li!' il!llli!! ::lllllllll!i 1i!i:iiil: '.!iiiliill:ilar Output (millions of barrels) 1,600 1,400 1,200 1, Figure 1 Texas Crude Oil Production and the Real Price of Crude Oil, Adjusted crude oil production, '\ / \... Crude oil,/'" \... ~:~,~.~.i~~. // Real price (per barrel) Price (1986 dollars) _... ~..._..._ 5 '54 '58 '62 '66 '70 '74 '78 '82 '86 For West Texas Intermediate percent per year in 1978 to 0.4 percent per year in 1984; then it rose again to 5.8 percent per year by This behavior reflects the underlying fact that in no year in the 1970s and early 1980s did reserve additions equal production, despite a near tripling of oil well completions. Only in the years did reserve additions exceed production. 2 While these data suggest that a price of $25 per barrel ($22.50 in 1986 dollars) probably would not succeed in stabilizing production in Texas, they do indicate that it probably could significantly slow the decline that began in the mid-1960s. Merely slowing the decline makes a great deal of difference in the absolute level of output and related economic activity, as the following calculation will show. If the decline rate of 6.0 percent in 1978 had persisted through 1984, production in the latter year would only have reached 718 million barrels. In fact, though, because of the reduction in the decline rate, production in 1984 was 845 million barrels, a difference of 127 million barrels, or 17.6 percent. As figure 2 shows, the real price of natural gas also rose markedly from 1973 to 1984, with the result that the decline rate fell to zero by the Figure 2 Texaa Natural Gaa Production Output and the Real Price, (billions of cubic feet) 10,000 Natural gas production 9,000 8,000 7,000 Price (1986 dollars) ,000 +-t ,......,...,...,_...,..._ '61 '65 '69 '73 '77 '81 '85 latter year. Since natural gas is a substitute for oil products in a number of important uses (e.g., boiler fuel or feedstock in industry), its price tends to rise in rough proportion to the price of oil; so a floor price for oil would imply a similar floor price for gas. It is likely that the response of gas production to a higher real price would be greater than that suggested by the figure. During the period covered by the chart, gas prices were subject to regulation. Gradual deregulation began in 1978, but there was considerable uncertainty in the industry about its exact pace and about implications for new exploration investments. The remaining resource base for gas in Texas is believed to be much larger than that for oil, partly because gas frequently occurs at depths only recently feasible to drill. So with complete deregulation of gas prices and a floor price of $25 per barrel for oil, there could be a substantial increase in Texas gas capacity and production in the decade ahead. The impact of oil and gas production on the momy of Texas is by no means confined to lie value of that production and associated 'moloyment. The impact is expanded through p:knloyment and output in oil field equipment tnanufacturing, oil field services, refining and petrochemicals manufacture, and transportation, to name only the most obvious industries. As we all know well from recent experience, the effect of an oil price and output slump extends to all sectors of the economy, from real estate to retailing, from finance to government. A recent study by Keith Phillips at the Federal Reserve Bank of Dallas indicates that during the period, the growth of total energy-related employment in Texas was about 4.5 times that of direct employment in "mining,'' which is almost entirely oil and gas production. In that period, the increase in Texas employment in all industries (except agriculture) was approximately 2.1 million workers. The increase in energy-related industries was.935 million workers, or 45 percent of this total.3 In a related study, S.P.A. Brown and John Hill found that (on a base of 1985) Texas employment declined percent for every $5 decline in the price of oil per barrel. 4 Using the methodology of this study, Phillips calculates that (on a base of 1989) when the economic base is less oriented to oil and gas production, the decline in employment would be 1.21 percent. The sug- Ii I I! I!!!::! i! ii! i!! : l!! 1111! I :! I! I! 11111!1 :! ; i!! i!! i; ~ i! : i 11 34r

3 West Texas Economy Shows Signs of Stabilizing Declining prices for oil and natural gas and continued softening of agricultural commodities in the 1980s are causal factors in the sharp declines in population and real retail sales of many small communities in West Texas during this time period. Despite the shrinking of the population base through 1988, real per capita retail sales in these communities have stabilized, with some increases indicated in the period. Better agricultural prices and the Crop Reserve Program initiated in 1986 are primary reasons for this reversal. The accompanying chart compares the counties including Amarillo and Lubbock with the remaining counties in the Texas Panhandle and South Plains. and Sante Fe Energy have contributed to this weakness. Though similar to Amarillo, Lubbock has experienced a slower rate of decrease. Real per capita retail sales indicate that the Houston and Amarillo economies have experienced greater stability since 1982 than the other cities. Lubbock's decline, even though sharp since 1979, has been less steep than Amarillo's; however, Amarillo had a higher per capita level of real retail sales than Lubbock $6,228 compared to $6,058 in Real Per Capita Retail Sales Thousands of dollars 10 8 r -- ~ - -- i--;...- /, I"""'... 6 r Real Per Capita Retail Sales Index 130 ~ ~... ;--~=~~... - ;:::: ;:::: ' 110 JOO 90 ~ ~=-r.=-: I'".._ I I\,- :;:::,;. ~ - ~, ~... ~.--.-1kL -11-n l 80 >-- L...mL...L...l...,...L...lllL.J L...L..J-...JC J...ll...,... L...L..J~~ 7Q '77 '78 '79 '80 '81 '82 -'83 '84 '85 "86 '87 ' 88 Amarillo Lubbock Panhandle Area South Plains = Source: Sales and Marketing Management, va rious issues, and author's calculations. Real per capita retail sales declined sharply from 1979 to 1984 for all counties, the sharpest decline occurring in the South Plains, with an index of in 1979 and 82.6 in 1984, a 33.1 percent drop. Since 1984, sales in the Panhandle and South Plains communities have stabilized, with Panhandle sales increasing from 87.9 in 1984 to 90.7 in However, figures for the cities of Amarillo and Lubbock have continued to decline, with Amarillo having the greater overall decline. Lost payrolls from firms such as Texaco Refining, Pioneer Corporation, Energas, Diamond Shamrock, Bell Helicopter, 4 r 2 f so 1 s2 s s Amarillo Lubbock DFW Houston = Source: Sales and Marketing ManagemenJ, various issues; Economic Indicators; and authors calculations. In conclusion, the Texas Panhandle and South Plains economies show the effects of declines in the agricultural and oil and gas industries. Because it is more involved in oil and gas, Amarillo has been affected to a greater extent. Stabilization of real retail sales in the smaller communities in West Texas appear to have positioned Amarillo and Lubbock so that they could materially benefit from a recovery in oil and gas and agriculture. The people of West Texas should, therefore, have a degree of confidence that the worst times are behind them and that economic activity is likely to blossom when oil and agricultural prices move higher in the future. - Jerry D. Miller Gene Edwards Professor of Finance West Texas State University I-

4 (IT gested floor price for oil is about $5 more than the current price. So its implementation could possibly result in a sustained increase in Texas employment of about 1.2 percent, with a roughly similar increase in gross state product. - Stephen McDonald Professor of Economics University of Texas at Austin and Mina Mohammadioun Economist Bureau of Business Research Notes 1. Task Force on oil price stabilization, Stabilizing U.S. Oil Prices: A Report Prepared for Governor William P. Clements, Jr., University of Texas at Austin, August William L. Fisher, "Changing Perceptions of the U.S. Oil and Gas Resource Base,'' Keynote Address to IBM Exploration and Production Software Symposium, Houston, Texas, June Keith R. Phillips, "Energy and the Southwest Economy,' ' The Southwest Economy, Federal Reserve Bank of Dallas, November S.P.A. Brown and John K. Hill, "Lower Oil Prices and State Employment," Contemporary Policy Issues, July 1988: Tracking the State's Economic Climate: Texas Business Review in 1989 December The Texas Economy: The Environment for Financial Institutions, Carol T.F. Bennett The Future of the Maquila Industry in Mexico, Elsie Echeverri-Carroll October The Texas Economy: The Housing Market in Texas, Susanne Ethridge Cannon Labor Force Trends in Texas, Deanna Schexnayder August The Texas Economy: Incubators and Economic Development, Raymond W. Smilor Lubbock: Education, Agribusiness, and Services, Charles P. Zlatkovich June The Texas Economy: Manufacturing Is the Key to Recovery, Mina Mohammadioun Natural Fibers and Food Proteins in Texas, Cheryl Chance April The Texas Economy: Will the Recovery Continue? Jared Hazelton Potential Export Markets and Sources of Foreign Direct Investment, Robert T. Green El Paso: International Industrialization, Charles P. Zlatkovich February The Texas Economy: School Finance and Economic Development, Jerry Olson Beaumont: An Economy in Transition, Charles F. Hawkins and J.M. Pearson :1,:iii1 :Ar

5 Employment and Unemployment Rate by Metropolitan Area Total nonagricultural employment Total employment Unemployment (thousands) (thousands) rate Percentage Percentage Area Nov Nov change Nov Nov change Nov Abilene Amarillo Austin Beaumont -Port Arthur Brazoria Brownsville-Harlingen Bryan-College Station Corpus Christi Dallas 1, , , , El Paso l Fort Worth-Arl ington Galveston-Texas City Houston 1, , , , Killeen-Temple Laredo Longview-Marshall I. I 8.3 Lubbock McAllen-Edinburg-Mission Midland Odessa I San Angelo San Antonio Sherman-Denison I Texarkana Tyler Victoria Waco Wichita Falls Total Texas 6, , , , Total United States 110, , , , Note: Data are not seasonally adjusted. Figures for 1988 have undergone a major revision; previously published 1988 figu res should no longer be used. Revised figures are available upon request. All 1989 figures are subject to revision, with the exception of Texas and U. S. total employment. Sources: Texas Employment Commission and U.S. Department of Labor, Bureau of Labor Statistics. Nonagricultural Employment in Five Largest Texas Metropolitan Areas Total Employment in Five Largest Texas Metropolitan Areas (January 1984=1.00) (January 1984=1.00) Fort Worth Fort Worth Austi n -... ~ il-+ff't+++~~t+ffl+t+~t+ff~lttti++t1+t-tt+ttt+ttttHttttHt tt1-H+t1Hffi~lttt'H++ll+++l~H++l-+++tl+++lf++HH++l-+++t+++lf++HH++I~ Note: This chart has been revised. Note: Th is chart has been revised.

6 BUREAU OF BUSINESS RESEARCH P.O. Box 7459 Austin, Texas Address correction requested. S~R~AlS ACQUISITIONS U~IW OF TX AT AUSTI~ GENERAL LIBRARIES PCL CAMPUS 0135.:. &i.itor: Lois Glenn Shrout Texas Business Review is published six times a year (February, April, June, August, October, and December) by the Bureau of Business Research, Graduate School of Business, University of Texas at Austin. Texas Business Review is distributed free upon request. The Bureau of Business Research serves as a primary source for data and information on Texas and on the dynamics of change. The Bureau's research program concentrates on the determinants of regional growth and development. The information services division answers inquiries by telephone and mail, responds to walk-in visitors, and offers computerized data from the 1980 census of the population and on manufacturing firms in Texas. The publications division produces periodicals, directories, books, and monographs on a variety of topics that shape the development of the Texas economy. Announcements The 1990 Directory of Texas Manufacturers should be available shortly after this issue of Texas Business Review is mailed. The 1990 edition includes changes on 43 percent of the firms listed in the 1989 edition and adds more than 1,300 plants not previously reported in the Directory. Information is updated monthly by Texas Industrial Expansion, which is automatically sent to each purchaser of the Directory. Price for the 1990 edition is $130 plus tax. For additional information, call (512)