How Does Fracking Affect Oil Prices?

Fracking, or hydraulic fracturing, is a technology used to extract oil and gas from the earth. The process creates fractures in rocks and rock formations by injecting specialized fluid and material like frac sand into cracks to force them to open further. According to the Independent Petroleum Association of America, hydraulic fracturing has helped boost the rate at which oil and gas can be extracted from wells, particularly in the United States.

Some economists argue that by increasing the currently available supply, fracking helps to lower oil prices on a global scale; however, there are other influencing factors that should be considered when looking at changes in oil prices.

Understanding Oil Prices

Basic economics states that as the supply of any good increases, its relative cost decreases. The degree to which these decreases occur depends on many factors, including the elasticity of the good. Even though oil is a natural resource, it has no productive economic use unless it is extracted. This means that the real supply, in a productive sense, is limited to what engineers and well technicians can provide. Fracking lowers the cost of oil to the extent that it allows real supply to expand.

The United States and Oil Prices

According to a paper by Manuel Frondel and Marco Horvath, the emergence of fracking stopped the steady decline in U. S. crude oil production that had occurred over the past decade. Fracking had a huge impact on global oil prices because the new technology allowed the United States to once again became one of the world’s largest crude oil producers, and the increased supply of oil put downward pressure on global oil prices.

Organization of the Petroleum Exporting Countries (OPEC) and Oil Prices

Before fracking, the Organization of the Petroleum Exporting Countries (OPEC) had largely determined global oil prices. OPEC is a cartel of 13 of the world’s major oil-exporting nations that coordinate the petroleum policies and prices of its members.

Using monthly data spanning from January 2000 to December 2016 and a supply-side model, Frondel and Horvath found a significant negative long-run relationship between oil price and OPEC supply volumes that exceed the announced OPEC quota. This finding indicated that OPEC still had a strong influence on global oil prices.

Other Factors to Consider

Frondel and Horvath did find that increased U.S. oil production due to fracking reduced oil prices. The authors conjectured that oil prices would have been around 40 to 50 dollars per barrel higher if the U. S. fracking boom had not occurred.

However, in the future, there will be limits to the extent fracking can be used to increase supply. Oil is scarce, and fracking is more expensive and complicated than traditional oil extraction. If the global supply of oil increases and oil prices drop far enough, then the high expense of fracking is no longer justified. In other words, the success of fracking eventually imposes a limit on itself, unless technological changes make the technique less costly.

The Bottom Line

Although the extent of fracking's influence on global oil prices is uncertain, without a doubt, the fracking boom is an example of a technological change in one country affecting international trade worldwide, not just oil prices. As more countries start to use fracking technology, there will be increased downward pressure on prices.

However, given the empirical evidence that oil supply shocks tend to have only modest effects on the price of oil. Frondel and Horvath suggest that a further drastic decrease in oil prices due to fracking is unlikely.