Free market capitalism is not really about long periods of quiet prosperity. In many ways, it is defined by short bursts of unanticipated innovation that rend the comfortable economic fabric. The current free fall in crude oil prices and the concomitant market volatility is yet one more example of this untidy process, which for many reasons could only happen in America.
Energy, and oil in particular, is the mothers' milk of all modern industrial economies. Beginning in the early part of the 20th century, the U.S. economy ramped up in lockstep with the growth in the American oil industry. Cheap and plentiful petroleum supplies allowed the Allies to out-produce the Axis, and set the stage for a quarter century of Western economic hegemony in the aftermath of World War II, even as we rebuilt the dilapidated industrial bases of our former enemies.
But during the early 1970s, U.S. oil production began to plummet as rapidly as it had increased, providing support for a theory known as "peak oil" that hypothesized a permanent decline in the United States and eventually in global oil production. By 2006, America was importing 65 percent of the crude oil it consumed and had suffered through two major economic recessions precipitated by OPEC embargoes and one triggered by a sharp spike in oil prices.
What happened next is a classic study in the disruptive power of capitalism. As with so many other unexpected and unpredictable technological advancements, innovation struck the oil patch and changed the game. An ingenious and persistent engineer named George Mitchell, immigrant son of a Greek goat herder, perfected a technique for drilling oil wells horizontally and fracturing rock under high pressure to release improbably large quantities of oil and gas from tight shale formations previously not exploitable by traditional methods. Practically overnight, the decline in American oil output was abruptly reversed, and by mid-2014 the U.S. regained the title as world's largest oil and gas producer, a salubrious development anticipated by practically no one.
Yet while $55 oil and $2-a-gallon gasoline are indisputably good news for families and industrial consumers, oil producers and service companies are being squeezed in a vice as they scramble to adapt to their recent embarrassment of riches. Many players have taken on significant debt to expand rapidly in pursuit of the boom. Now a long round of bankruptcies, consolidation, downsizing and rationalization is likely to follow as the industry adjusts to the new environment.
This is the uniquely fertile mechanism that makes free-market capitalism the engine of economic growth. Austrian economist Joseph Schumpeter referred to this purposefully disruptive process as "creative destruction." Schumpeter conjured up a biological metaphor in describing the restless destruction and re-creation as a series of mutations that systematically discard older obsolete organisms in the process of creating newer, more productive ones.
The U.S. energy industry appears to be in the midst of just such an epochal round of creative destruction. Previous examples include the Industrial Revolution, the transcontinental railroad, the transistor and the Internet delivered immeasurable prosperity and progress but left behind painful dislocations. Hydraulic fracturing is just such an unpredicted, disruptive technology that appears now to be transitioning from leading edge into a more mature consolidation phase. Markets are presently trying to adjust to the new reality of more abundant and affordable energy supplies, and as always the adjustment process can be painful and prolonged. But the ultimate payoff in growth and prosperity is worth the effort. Only in America.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.