The right price for a barrel of oil

Is there such a thing as the "right price" for a barrel of crude oil?  Such a price would need to be optimal not only for producers but also for consumers as well.  Such a price would allow the oil companies to make profits while also allowing the rest of the economy to work properly.  On page 16 of his 2020 book, James Howard Kunstler summed up this precarious balance with this tidy formulation: "Oil over $75 a barrel crushes economic activity, and oil under $75 bankrupts oil companies."

Well, in 2020, when crude oil averaged "under $75," 108 oil and gas companies in North America filed for bankruptcy and set the record for bankruptcy debt, NS Energy reported.  Some of those failing oil companies were already marginal operations and were working oil fields that required high prices just to break even.  Even so, for the oil sector, 2020 was characterized as "arguably the most devastating year in history."

With the price of crude oil rising so steeply of late, one bumps up against the term "oil burden."  Véronique Riches-Flores came up with the concept, which can be turned into a number with this math: "the volume of oil consumed multiplied by the average price and divided by nominal gross domestic product."  That gives us "the proportion of the world economy devoted to oil."  This writer cannot say how useful this economic indicator is, but it seems a valid way to gauge the oil "overhead."

In July of 2021, The Wall Street Journal ran "Why Rising Oil Prices Are Unlikely to Kill the Economic Recovery," which touched on the oil burden.  This was just after U.S. crude oil futures topped $75 a barrel:

One indicator to watch is the oil burden, or the cost of oil as a proportion of gross domestic product, which is a bellwether for oil's impact on growth. That indicator is expected to rise to 2.8% of global GDP for 2021, assuming an expected average oil price of $75 a barrel this year, according to Morgan Stanley. That, though, remains below the long-term average of 3.2%.

Also in July of 2021, ran "High Oil Prices Threaten The Global Economic Recovery," in which we read that the then-current price of $75 a barrel was "not as high as to seriously slow down economic growth" and that "[o]il would have to average $10 a barrel higher — $85 — in order for the so-called oil burden to reach the long-term average."

In October of 2021, Arab News ran "What price of crude is too high? The answer will surprise you" by Michael Rothman, who also zeroed in on oil burden:

As crude oil prices climb to their highest levels in 7 years, the question our clients are asking us is, how high is too high? We will say for now that current prices are nowhere near that point, and the way we arrive at an answer is by analyzing the "oil burden." ...

The oil burden is the price at which global expenditures on oil rise above a level equating to 5 percent of the global gross domestic product. Our analysis has found that expenditures on petroleum above this percentage of GDP tends [sic] to act as a dampener of economic activity. ... the price of Brent crude would need to average $130 per barrel (for the year) in order to push expenditures on oil to the 5 percent of GDP mark.

Mr. Rothman predicted continuing upward pressure on the price of oil.  He also concluded that the "most contentious" part of the world oil situation is in the U.S., and that means shale oil.

In "US shale oil production is in its twilight phase" from September 2021, Rothman wrote of his 2019 pre-pandemic prognostications for ever-slower growth for U.S. shale oil (italics added):

Essentially, we forecast that global oil demand will see an eventual (and full) rebound from negative pandemic-induced effects, but that non-OPEC oil supply will not see a commensurate recovery. Let us talk about the "why."

Back in 2019 (so, prior to impacts linked to the pandemic), we were publishing work suggesting that US crude oil production would likely decline post-2020. The analyses were admittedly greeted with a great deal of skepticism, but nevertheless centered on a key finding in data showing that US crude oil production was growing, but at a slower-and-slower-and-slower rate. ...

The inordinate focus that has been evident on this particular source of oil supply relates to the fact that for the past 10 years, almost 100 percent of all non-OPEC oil growth came from US shale.

In "Crude prices are well over $55, so where is all that shale oil?" from November 2021, Rothman repeated his dim outlook for shale oil:

A key view we have shared with clients for years was that US shale oil was never going to be the solution to the world's need for increased crude supply. ...

For 2022, we believe we are facing the same sort of issue, with current consensus projections for US oil supply (and non-OPEC in general) appearing too optimistic. Keep in mind that since the 2014 high watermark, global capital expenditures for oil production have been cut by a collective $2.2 trillion. ...

When you place all that in the proverbial blender, it translates into meaningful upward pressure on crude prices.

Much less than being "the solution to the world's need for increased crude supply," U.S. shale oil can't even supply the U.S., at least for right now.  As Rothman points out, one of the problems with shale oil is that the average lifespan of shale wells is much shorter than for conventional wells.  This is due to the physics of fracking.  So the industry "always has to find and develop new sources to offset declines from existing output."

So America has lost a bunch of energy companies, has lost her energy independence, and has gone back to importing oil from folks who don't much care for us.  OPEC appears to be back in the catbird seat.

Gird your loins, America: we're headed into a twilight struggle with higher oil prices, and that will make the "oil burden" more burdensome.  On Jan. 23, showed the price for a barrel of WTI crude as $85.14.  (If that seems a mite high, then check out the prices on this chart.)

One can take issue with James Kunstler's $75 price point.  One might argue that it's too high or too low.  Or one might argue that the whole idea of there being a price "point" is wrong and that there is a range or band of feasible prices by which the oil business and the rest of the economy can co-exist.

But the larger truth of his formulation is that oil prices, just as with the price of any essential, can be too high, and they can be too low.  That insight seems commonplace, but it may be beyond many Americans right now as they're worried about the future and about falling behind.  And they're also struggling with inflation, which can be fueled by rising energy prices.

Be that as it may, oil producers have subsidized consumers for far too long.  It's high time for U.S. oil companies to start turning a profit, and at whatever price the market will bear.

Jon N. Hall of ULTRACON OPINION is a programmer from Kansas City.

Image: Pixabay, Pixabay License.

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