The Shale Revolution and the Dynamics of the Oil Market

Bottom Line: The U.S. shale oil revolution since 2007 has been brought about by advancing drilling technologies (“fracking”). Domestic crude oil production has more than doubled, staggering growth that has also been substantial in the context of the global oil market. The present study models the market to help quantify the impact of the shale revolution on oil prices and output. Not just adding geopolitical and strategic benefits for the U.S., the advent of U.S. shale has substantially lowered global oil prices, no small feat since shale accounts for 10% of global output. For example, using 2018Q4, global oil prices would have been 36% higher had the shale revolution not occurred. The U.S. shale revolution has also reduced the country’s vulnerability to price shocks, important because such higher prices often lead to an economic recession.

Since 2007, the U.S. shale revolution, the more than doubling in domestic crude oil production brought about by the technological developments in hydraulic fracturing and horizontal drilling, has brought longlasting changes to the world oil market.

This study builds and estimates a dynamic model of the oil market to help quantify the impact of the rise of shale on oil prices and output.

It also looks at, over the short- and long-run, production decisions of conventional and shale oil producers, as well as the strategic production decisions of the key players in OPEC (the Organization of the Petroleum Exporting Countries). 

Also factored into the model solution and estimation, is that the sample period is one of transition from a steady state where U.S. shale oil production was virtually nonexistent to one where shale oil is a major source of world oil supply, now at 10%.

There is also a time series on oil prices and output to estimate key structural parameters in the model and then using these to identify the source of fluctuations in global oil prices and production.

The advent of U.S. shale lowered oil prices substantially: prices would have been approximately 36% higher in 2018Q4, for instance, had the shale revolution not occurred.

In addition, shale production acts as a buffer to demand and non-shale supply shocks, lowering the flucations of oil prices and even output itself. 

Yet still, OPEC’s core producers, by acting strategically, have mostly maintained their market share, suggesting shale’s increasing share of world production has come largely at the expense of other conventional producers.

There has also been a drop in oil market volatility brought on by shale that has helped smooth the business cycles of oil exporting countries and install more stable growth paths.

For the U.S., not just lower prices and more market influence, shale has given the country more geopolitical and strategic power, especially as it switches to being a major crude exporter less dependent on imports from distant suppliers.

The shale revolution has also made the U.S. less vulnerable to oil price shocks, times when prices spike and have typically led to recessions over the past decades.

Findings:

• Since 2007, the U.S. shale oil revolution has led to significantly lower oil prices and less volatility in the global market. 
• The key OPEC producers have mostly kept their market share in response but have ceded geopolitical and strategic influence to the U.S.
• Shale has made the U.S. less vulnerable to imported oil and global price spikes, a critical domestic benefit for its economy. 

Read the full study here.