crude oil
Dan Reed

Low Oil Prices Could Cause Problems

There’s a good news/bad news situation developing in the price of oil.

First, the good news: U.S. oil prices are trending down thanks to softening global demand, a strong dollar, and dramatic increases in North American production.

Now the bad news: U.S. oil prices are trending down thanks to softening global demand, a strong dollar, and dramatic increases in North American production.

Average Gas Prices Drop Significantly

It’s typical for gasoline prices to fall at this time of year as refineries move into the seasonal production and switch to winter blends. But this year there’s significant additional downward pressure on prices. As of Sept. 25, the average price per gallon in cities in several lower-tax states was just below $3. And even the national average of $3.35 a gallon (held high by higher-tax states) was down 10 cents from the same time a year ago.

That’s great for average Americans. Goods are less expensive to ship. Traveling to work or for personal reasons is less costly. People have more cash in their pockets to spend or, gasp, pay down debt or save. Perhaps more importantly, the $5 to $10 a week in savings at the pump the average American is seeing right now breeds greater economic confidence, which can change the nation’s economic zeitgeist and encourage greater economic activity across the board.

Longer term, however, some leading energy industry thinkers are beginning to worry that declining oil – and natural gas – prices could trigger a significant slowdown in the one sector of the economy most responsible for the job growth and economic vitality the United States has seen in its long, slow and less-than-fully-satisfying recovery from the deep recession that began in 2008.

Low Crude Costs Could Threaten Global Price System

Energy industry research, analytics and consulting firm Wood Mackenzie issued a September report warning that the price of U.S. crude could tumble $30 a barrel below the price of Brent and other international benchmarks in the decades ahead. Such a dramatic price divergence would be the result of a dramatic improvement in North American recovery rates, driven by new drilling technologies that could add an extra 1.5 to 3 million barrels a day to U.S. production. That would be on top of the 8.5 million barrels being produced in North America this summer.

Unfortunately, such dramatic gains in production – approximately 25 percent more production than previously forecast – would contribute to a glut of oil in the U.S., which is prohibited by law from exporting crude and cannot now process all that crude into gasoline and other refined fuels. The result would be declining prices in North America relative to other parts of the world.

In response, Wood Mackenzie warns, energy companies would dramatically reduce their exploration and production work, leading to layoffs and reduced purchase of services to support oilfield operations and personnel. The larger national economy would be damaged by job losses and reduced economic vitality. Those economic hits would more than offset the positive impact of modest consumer savings at the pump.

Natural Gas Currently Experiencing Similar Issue

A similar set of circumstances already is underway in the natural gas market, where production is nearing 31 trillion cubic feet annually, up 32 percent from 2005. All that production slowly is creating a growing glut and lower prices.

Today, natural gas is selling for less than $4 per thousand cubic feet, down more than 11 percent from June and down more than 70 percent from 2008. That drop is largely the result of the production boom created by the successful employment of hydraulic fracturing and drilling technique across North America in the last six years. But fracking may be reaching the point of becoming too successful.

The number of rigs drilling for gas in the U.S. has dropped to 300 today from more than 1,300 in operation six years ago, and there are increased warnings that if natural gas prices go much lower, many of those remaining rigs will be mothballed. At prices nearing $3, it becomes an uneconomic proposition to pump already-discovered natural gas out of the nation’s biggest and most active shale formations like the Haynesville, Barnett, Eagle Ford, Bakken and Marcellus plays. And exploration work, by definition, becomes a money-losing proposition long before prices get so low that merely pumping already discovered gas out of the ground stops making financial sense.

Combination of Factors Impacting Energy Economics

Thus, the recent decline in U.S. energy prices is beginning to create an economic tightrope over which the nation might have to do a balancing act.  Lifting the ban on the export of at least some American crude likely would reduce the growing glut and, over time, stabilize prices, probably somewhat above today’s price levels. But consumers likely would not appreciate higher prices. And politically, there’s little movement toward lifting the ban.

Meanwhile, demand for natural gas, which can be exported, is softer than expected thanks to weakening economies in China, India and other developing regions. Some experts suggest that a modest weakening of the dollar on foreign exchange markets could help reduce the amount of divergence between use and foreign benchmark crude prices, but there are no foreseeable circumstances that would cause the dollar to lose value. Further, it’s unclear that narrowing the crude price divergence would have a truly significant impact on energy industry economics.

Thus, that energy economics tightrope is likely to be in place for an extended period of time. And it’s a good news/bad news situation to which Americans likely will have to get accustomed.

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