Steven Hayward posted an article at Power Line today about the recent drop in oil prices. As of 4 pm today, oil was listed at about $58 a barrel. So what does this mean?
The article reports:
Our Rate of Return (ROR) drops to 10% on our wells at $55 oil. However, this assumption assumes no drop in costs to drill wells and no contraction in the large differential ($10 to $12 per barrel) between Bakken and WTI oil. In reality our ROR would actually be above 10% at $55 WTI oil price as our costs to drill would also come down. There are plenty of drilling locations that would have above 10% ROR at $40 oil. Even more drilling locations would require $70, $80, or $90 oil prices for that ROR. Of course, drilling will slow down long before you get down to a 10% ROR. Most will want at least a 20% ROR. Of course the quality of the operator matters in addition to the drilling location. . .
Bottom line is that the Saudis want to chill investment in new oil supply to help protect OPEC’s future. In round numbers we have had about 5 MBOPD increase in world oil demand over the last 5 or 6 years. Over the same time period US oil production has grown from nearly 4 MBOPD (from 5 to 9 MBOPD) — 80% of the increase in WORLD demand! This is NOT good for OPEC. I suspect that we will have ugly oil prices ($60 – $75) for around a year as that is long enough to stop many current oil supply investments and, more importantly, serve to chill the appetite for future large investments in oil supply growth (deep water, arctic, marginal shale, marginal tar sands, etc) which is the Saudi goal in my opinion. I do not believe that the current price ($65) is a sustainable price going forward. It would not encourage enough new supply to balance world demand which itself would be goosed upwards with the lower prices. I suspect that after this ugly price period ends, we likely see oil bouncing around the $75 to $95 range or something like that.
Of course all of this depends on the state of world economy which has many significant challenges such as at the required unwind, or more likely significant revamping, of the unsustainable entitlement states over the next two decades. I personally believe that the Euro currency was a very idea from the start and is damaging for Europe and unsustainable as an institution. The unwind of the Euro within the next 5 or 10 years could also cause significant economic headwinds for the world economy.
This game has been played before–when America is reaching energy independence, lower the price to avoid further exploration. We are fools if we fall for this. As soon as OPEC thinks America is not interested in developing its own resources, the price will go back up to where it has been in recent years. Regardless of the price, energy independence is always a good idea for security reasons. Energy independence also frees America up to support democracies in the Middle East rather than dictatorships.