Will Oil and Gasoline Prices Stay Low?

We’ve enjoyed low gasoline and heating oil prices for a few years now, since worldwide crude oil prices plummeted from over $100/bbl in early 2014 to less than half that today. Actually, the current pricing of $45-55/bbl represents a “comeback” of sorts, since crude had dipped as low as $26/bbl during the past year.

The benefits of low oil and gas prices are obvious and unmistakable to everyone. The two obvious questions are 1) How did we get here and 2) how long will it last?

In 2014, three main factors came into play:

  1. The sluggish world economy (especially in China) in 2014 put a drag on world oil demand.
  2. U.S. oil production ramped way up at the same time, due to new U.S. shale field output (new exploration and drilling technology enabled U.S. to finally act upon the “Drill, baby, drill!” sentiment espoused by many).
  3. With supply and demand dramatically out of balance, crude oil pricing fell, from over $100/barrel to under $50.

So the Saudis -- looking at their oil-derived riches evaporate before their eyes due to drastically reduced oil revenue -- are faced with a difficult situation: They could reduce their oil output, and the world’s available oil supply would fall and prices would recover. But that would only be a partial solution. It would still leave the U.S. shale oil producers -- the new, disruptive players in the game -- very much untouched and very much a threat to Saudi Arabia’s ability to remain the prime influence on world oil pricing.

Therefore, the Saudis embarked on a strategy designed to drive the U.S. shale producers out of the game altogether, to ruin them, to permanently remove them from the playing field.

Here’s what the Saudis did: they increased their oil production, in the hopes that world market pricing would fall even further and eventually get so low that the U.S. shale producers couldn’t make any money producing oil. Once shale was bankrupted and the U.S. was back to being a 2nd-tier oil player, the Saudis could take the necessary steps to see that crude oil pricing rose again -- only now they’d have their “rightful” market share back, without those pesky U.S. shale folks.

Saudi rationale: Their Cost of Production (COP) is about $9/barrel to get their oil out of the ground in those nice, easy desert oil fields, while U.S. shale COP is about $45/barrel. The Saudis were willing to see oil pricing fall in the near term (which it has) in order to gain a long-term advantage.

But there are two really, really big flies in the Saudis’ ointment:

  1. U.S. shale extraction technology keeps pushing the U.S.’s COP lower and lower. Yes, some shale fields have slowed or even closed, but many are still going gangbusters -- and it’s estimated that their break-even COP is now down to below $25/barrel. The Saudis are chasing a moving target.
  2. That $9 COP for the Saudis? It’s a meaningless figure. Their breakeven sales number -- based on their national governmental spending -- was $99/barrel in 2014. That’s what oil needs to sell for in order for the Saudis to maintain their level of governmental spending. And governmental spending is all they have to prop up their economy, since it’s not an open-market, capitalistic economy and oil is pretty much their sole product. It’s not like the Saudis produce and export food or cars or electronics or clothes or medicine or Hollywood movies or steel or plastics or anything. No, they just have oil. And it has to sell at $100 a barrel for them to be successful.

Just recently, the Saudis have cried “Uncle” on their original approach and are now looking for the OPEC (Organization of Petroleum Exporting Countries) cartel to agree on oil production cuts, to restrict the world’s supply and force prices to rise.

The problem facing the Saudis is human nature, as it translates to national financial policy. Many cash-strapped OPEC members want to sell as much oil as possible, even at the current lower pricing, in order to maximize their near-term revenue. Libya, Iraq, Iran, and Nigeria have insisted on being excluded from any agreement on production cuts, causing a German energy analyst to quip that “OPEC” now stood for “Oil Producers Exempt from Cuts.”

Brazil, although not an OPEC member, is a major world oil supplier, producing nearly 3 mil bbl/day, putting Brazil in the no. 9 spot of largest producers. Newly-discovered reserves could push their ranking even higher in the next few years. With their economy having been wrecked by decades of inefficient government policies, waste, and fraud, Brazil needs the oil revenue now. They’re not about to agree to any voluntary production cut. The same holds true for many other large non-OPEC producers, like Russia (no. 3 in the world), Mexico, Canada, etc. Therefore, it doesn’t seem that the world supply end of the equation is going to change markedly in the near term, regardless of what the Saudis do. The worldwide oil glut will probably continue.

World oil demand is tougher to predict. Thus far, indications are that the world’s economies will remain on a sluggish growth path for the foreseeable future, so demand for oil-based products in commercial settings is on a slow-growth trajectory. Additionally, ever-increasing fuel efficiency in cars, trucks, and aircraft is having a meaningful effect on usage. Thirdly, “alternative, renewable” fuels -- as haltingly erratic as their growth has been, for any number of reasons -- are nonetheless assuming an increasingly significant share of the world’s energy mix.  It all adds up to the actual usage demand for oil increasing at a very modest rate for the next several years. Outside of the jolt of a geopolitical crisis that would cause a crude oil price spike not directly related to traditional supply and demand concerns (such as Iran closing down the Strait of Hormuz or some major terrorist act crippling Russia’s production), the oil demand near-future landscape appears relatively uneventful.

As far as the U.S. is concerned, the impact of increasingly strict environmental regulations looms menacingly over this country’s traditional oil-based energy production. The environmental lobby is trying to limit fossil-fuel exploration and production, in service to a Green agenda. This article is not taking a pro or con position on that, other than to simply observe that it exists, and said regulations will be strengthened or weakened depending on the predilections of the administration in power at any given time -- with a commensurate impact on U.S. fossil fuel energy production.

Therefore, the answer to “Will prices stay low?” should be “Yes,” since the supply of oil looks to remain strong and worldwide demand -- primarily due to slow-growing economies and the increasing significance of alternative energy sources -- is not poised to dramatically spike any time soon. The wildcards are the restrictive impact of any newly-invigorated U.S. environmental regulations and the always-unpredictable nature of international geopolitical activities.

We’ve enjoyed low gasoline and heating oil prices for a few years now, since worldwide crude oil prices plummeted from over $100/bbl in early 2014 to less than half that today. Actually, the current pricing of $45-55/bbl represents a “comeback” of sorts, since crude had dipped as low as $26/bbl during the past year.

The benefits of low oil and gas prices are obvious and unmistakable to everyone. The two obvious questions are 1) How did we get here and 2) how long will it last?

In 2014, three main factors came into play:

  1. The sluggish world economy (especially in China) in 2014 put a drag on world oil demand.
  2. U.S. oil production ramped way up at the same time, due to new U.S. shale field output (new exploration and drilling technology enabled U.S. to finally act upon the “Drill, baby, drill!” sentiment espoused by many).
  3. With supply and demand dramatically out of balance, crude oil pricing fell, from over $100/barrel to under $50.

So the Saudis -- looking at their oil-derived riches evaporate before their eyes due to drastically reduced oil revenue -- are faced with a difficult situation: They could reduce their oil output, and the world’s available oil supply would fall and prices would recover. But that would only be a partial solution. It would still leave the U.S. shale oil producers -- the new, disruptive players in the game -- very much untouched and very much a threat to Saudi Arabia’s ability to remain the prime influence on world oil pricing.

Therefore, the Saudis embarked on a strategy designed to drive the U.S. shale producers out of the game altogether, to ruin them, to permanently remove them from the playing field.

Here’s what the Saudis did: they increased their oil production, in the hopes that world market pricing would fall even further and eventually get so low that the U.S. shale producers couldn’t make any money producing oil. Once shale was bankrupted and the U.S. was back to being a 2nd-tier oil player, the Saudis could take the necessary steps to see that crude oil pricing rose again -- only now they’d have their “rightful” market share back, without those pesky U.S. shale folks.

Saudi rationale: Their Cost of Production (COP) is about $9/barrel to get their oil out of the ground in those nice, easy desert oil fields, while U.S. shale COP is about $45/barrel. The Saudis were willing to see oil pricing fall in the near term (which it has) in order to gain a long-term advantage.

But there are two really, really big flies in the Saudis’ ointment:

  1. U.S. shale extraction technology keeps pushing the U.S.’s COP lower and lower. Yes, some shale fields have slowed or even closed, but many are still going gangbusters -- and it’s estimated that their break-even COP is now down to below $25/barrel. The Saudis are chasing a moving target.
  2. That $9 COP for the Saudis? It’s a meaningless figure. Their breakeven sales number -- based on their national governmental spending -- was $99/barrel in 2014. That’s what oil needs to sell for in order for the Saudis to maintain their level of governmental spending. And governmental spending is all they have to prop up their economy, since it’s not an open-market, capitalistic economy and oil is pretty much their sole product. It’s not like the Saudis produce and export food or cars or electronics or clothes or medicine or Hollywood movies or steel or plastics or anything. No, they just have oil. And it has to sell at $100 a barrel for them to be successful.

Just recently, the Saudis have cried “Uncle” on their original approach and are now looking for the OPEC (Organization of Petroleum Exporting Countries) cartel to agree on oil production cuts, to restrict the world’s supply and force prices to rise.

The problem facing the Saudis is human nature, as it translates to national financial policy. Many cash-strapped OPEC members want to sell as much oil as possible, even at the current lower pricing, in order to maximize their near-term revenue. Libya, Iraq, Iran, and Nigeria have insisted on being excluded from any agreement on production cuts, causing a German energy analyst to quip that “OPEC” now stood for “Oil Producers Exempt from Cuts.”

Brazil, although not an OPEC member, is a major world oil supplier, producing nearly 3 mil bbl/day, putting Brazil in the no. 9 spot of largest producers. Newly-discovered reserves could push their ranking even higher in the next few years. With their economy having been wrecked by decades of inefficient government policies, waste, and fraud, Brazil needs the oil revenue now. They’re not about to agree to any voluntary production cut. The same holds true for many other large non-OPEC producers, like Russia (no. 3 in the world), Mexico, Canada, etc. Therefore, it doesn’t seem that the world supply end of the equation is going to change markedly in the near term, regardless of what the Saudis do. The worldwide oil glut will probably continue.

World oil demand is tougher to predict. Thus far, indications are that the world’s economies will remain on a sluggish growth path for the foreseeable future, so demand for oil-based products in commercial settings is on a slow-growth trajectory. Additionally, ever-increasing fuel efficiency in cars, trucks, and aircraft is having a meaningful effect on usage. Thirdly, “alternative, renewable” fuels -- as haltingly erratic as their growth has been, for any number of reasons -- are nonetheless assuming an increasingly significant share of the world’s energy mix.  It all adds up to the actual usage demand for oil increasing at a very modest rate for the next several years. Outside of the jolt of a geopolitical crisis that would cause a crude oil price spike not directly related to traditional supply and demand concerns (such as Iran closing down the Strait of Hormuz or some major terrorist act crippling Russia’s production), the oil demand near-future landscape appears relatively uneventful.

As far as the U.S. is concerned, the impact of increasingly strict environmental regulations looms menacingly over this country’s traditional oil-based energy production. The environmental lobby is trying to limit fossil-fuel exploration and production, in service to a Green agenda. This article is not taking a pro or con position on that, other than to simply observe that it exists, and said regulations will be strengthened or weakened depending on the predilections of the administration in power at any given time -- with a commensurate impact on U.S. fossil fuel energy production.

Therefore, the answer to “Will prices stay low?” should be “Yes,” since the supply of oil looks to remain strong and worldwide demand -- primarily due to slow-growing economies and the increasing significance of alternative energy sources -- is not poised to dramatically spike any time soon. The wildcards are the restrictive impact of any newly-invigorated U.S. environmental regulations and the always-unpredictable nature of international geopolitical activities.