CHEAP OIL WILL IT LAST?

OIL PRICES ARE DOWN, WILL THEY STAY THERE?

Since June 2014 oil prices have plunged to their lowest levels in a long time. In June a barrel of sweet crude was selling for $115 dollars....it is now ( figure for late December 2014) $55 dollars a barrel. Gasoline prices have fallen from (variously) $3.79 to today in Peru, Vt. $2.59 or about a third less than what we had been paying only a few months ago. Will these savings continue or is this just a seasonal windfall?
What happened?
It's simple supply and demand. Too much supply, not enough demand. On the "not enough demand" side, the picture is clear. The big guns of crude oil consumption, the USA, and China both have economies which are either stuttering along or just slowly recovering (USA) from the Great Recession. Oil consumption is down. There are simply fewer machines, automobiles, trucks and heavy equipment in operation. There are fewer long-haul deliveries, fewer bull dozers and road scrapers, in use. Then too, in these countries, and in the rest of the world, the elevated prices of oil during the last boom, engendered a counter response to the dear oil-efficiency. In the USA and most industrialized nations we are driving fewer miles and in smaller more compact cars and trucks. Ford Motors has even introduced a more efficient..low weight..F150 truck-- of its most popular models offered with a significantly lighter aluminum body..which will use considerably less fuel than the old models.

On the supply side there are several reasons, but the major one is that all world producers are simply pumping at near maximum capacity. Libya, with the largest oil reserves in Africa, had been expected to remain in low-production mode due to the political turmoil resulting from the civil war in which Col. Muammar Gaddaffi was overthrown and killed in 2011. However, surprisingly, and no doubt with the help of interested parties based in the USA , Libyan post-Civil War production surged from only 300,000 barrels per day ( bbl/day) to a million barrels a day (1,000,000 bbl/day) in late 2014. (Libya remains a turbulent area, however, in which the region known as the Libyan "oil crescent" is being continually contested by rival militias. Just a few days ago, around Christmas, a stray she'll from an insurgent rocket..set off a huge fire which consumed millions of barrels of the black stuff. It was snuffed out yesterday. So presumably production will continue. )

Also on the supply side. In a major development in the US, a new technology termed "fracking" and horizontal drilling have made substantial changes in US oil production. Since about 2012, US drilling companies have driven over 20,000 new wells into the North Dakota, Bakken oil shales. These so called "tight oil" wells can be highly productive when drilled using the new technology. In this method a standard well is driven down into the oil bearing strata. At this point the well bit is manipulated so it will drill horizontally to follow the trend of the underground oil-bearing rocks. As it is drilled along, parallel to confining strata, water mixed with other chemicals and sometimes fine solids too, are pumped down from the surface at very high pressures to crack or fracture ( hence the verb "fracking") the bearing strata and encourage the flow of the trapped "tight oil" into the well and then up to the surface.

Prior to this new technology, US domestic oil production averaged approximately 4 million barrels per day (4 mil bbl/ day) much of it from wells in the west Texas Eagle Ford Shale . The USA consumes on average about nine million barrels per day (9 mil bbl/ day) so our domestic production met only less than half of our needs. We were require to satisfy the remainder by importing about five million barrels per day from the world market. But with the recent new production from the twenty thousand wells in the Bakken Shale, US production in mid 2014 rose to a bit more than 9 million bbl/ day. We were oil independent at last! It is noteworthy to point out that amount of production is is approximately equal to that which Saudi Arabia produces per day. So at the present time the USA and Saudi Arabia are about equal in production. Naturally, with the additional five million barrels per day from US Bakken production, the USA did not have to import that extra oil from abroad and that oil, as well as the additional million barrels of unexpected oil from Libya, are the sources of the oil glut we are experiencing now.

Normally under these circumstances the Saudis, would simply reduce their production level to keep the prices of oil stable. However, in this instance they chose not to. To reduce their production and that of the the other OPEC members to take up the amount produced by the USA a would have cost these producers dearly. It would mean a big drop in income. They chose to continue producing their 9mil bbl/ day and other OPEC members followed suit. They could not act independently, since their production levels are much less than those of Saudi Arabia.

Why have they continued to pump oil, unwilling to decrease supply to jack up the world price ?

The Saudis have made a strategic decision to protect their market share. They might take a short term loss, but high prices...prices above the $50 dollar level, will only encourage US investment in the oil fields of North Dakota. If they were to move to keep oil prices high, they would only be encouraging investors in the USA to continue drilling new wells. To protect their market share over the long haul, they must continue depress prices and to pump and sell their oil. With their low production costs will continue to make a profit, although not quite as much as before.

The underlying reason. Saudi wells are established and their premium quality, light-sweet crude in many wells still rises to the surface under pressure. Their production cost are low, in their older fields, as low as $28.00 per barrel. While the cost of production in the US Bakken Oil Shales are much higher. North Dakota oil is profitable only when world market oil prices reach above $65 or $70 dollars per barrel. Right now, with oil at $55 dollars per barrel and falling, "tight oil" costs more to produce than a oil company can sell it for on the world market. Bakken oil is not a good investment right now. The low prices have transformed the world oil market and investment portfolios of many entrepreneurs.

And that goes double for Canadian tar sands oil, extracted so inefficiently and laboriously and with such high environmental costs. The burning political question of US support or non-support for the infamous XL pipe line is now moot. Production costs are very high for tar sands which were only marginally profitable when oil was selling at $100 dollars a barrel. And that marginal profitability was the case only IF the Canadian producers could transport their heavy oil sludge to refineries (rather than by train) cheaply across the USA, by way of the XL Pipe Line. Oh yes, and don't let anyone sell you some cheap shares in an Arctic oil well, where production cost are well over $100 dollars a barrel. Not when oil is settling in at $45 to $50 dollars per barrel. At those prices only the oil sheiks can make a profit.

Thus the short answer to the above question is: Yes is seems very unlikely, that the Saudis will want to give up their market share and encourage competition by helping to raise prices. So under the present circumstances, I would expect low prices to continue. When (and if ) the world economy builds up a full head of steam and drives up consumption, we may then see prices rising again. Or if some calamity befalls one of the major producers, such as war, earthquakes, floods, or pestilence or any factor that may reduce production, then prices will climb again. So for the near term expect oils prices to remain low.

If you were looking to give up that cramped, little Prius capable of 50 miles per gallon for a nice new American Ford 150 truck 4x4, with the big cab, and the knobby tires, well that may be possible now.

But remember, lower prices put into play counter pressures. Low prices encourage increased consumption and waste. Higher usage will inevitably cause the glut to eventually dissipate and prices to increase again. So maybe go with the Ford 150 with the light aluminum body...and hedge your bet.

Rjk