Monday, March 09, 2015

Lower Gas Prices – Excess Crude Oil

You already know that oil prices are lower than they have been in a long time, in part because U.S. oil production is higher than it has ever been and still climbing steeply.  You might not know that there is more oil coming out of the ground than can be stored or refined. Right now crude oil cannot be exported, only refined oil products can be exported.  It takes years to build a new refinery, so you have to wonder how long these conditions will last before they either allow crude oil to be exported or production of oil grinds to a halt.

Accompanying to this chart, courtesy of the oil field services company Baker Hughes, may be the most dramatic illustration of economic reality you will see this month.  It shows how the U.S. has increased the millions of barrels of oil per day that were pumping out of U.S. soil in the past four years.  Looking at the orange line rising ever-more-steeply, you wonder whether oil prices will ever go back up to previous levels.

But then you see the purple line, which tracks the number of active oil rigs that are out there looking for new sources of oil.  The last quarter of 2014 and the first few months of this year have created a dramatic bear market for drilling rigs in action.  In just two fiscal quarters, the number of rigs in the field has dropped almost by half, and there is no sign that the trend is slowing down.

What does that mean?  Nothing in the short term, since the orange line represents existing production, but longer-term, you have to expect one of two things to happen:

1.     That fewer active rigs will mean fewer new wells and at the very least a leveling out of oil production. 
2.     Oil companies will start to lobby Washington for the right to export their excess oil production.

Oil prices may be down today, but if oil companies have their way that doesnt mean supplies will outrun demand forever.  Enjoy your lower gas prices while you can.