Behind The Drop In Oil Prices

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:

I decided to reach out to the CEO of a very successful private oil exploration company for his inside opinion, and this is what he tells Power Line:

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.

Crippling The American Energy Sector

One of the problems in the economy today is the price of gasoline at the pump. Two years ago it cost me $25 to fill up my car, now it costs $50+. I am sure my story is not unique, and the cost of gasoline has a negative impact on everyone’s budget. There are very obvious ways to bring down the cost of gasoline at the pump–build refineries, drill everywhere, and generally develop a sane energy policy for America. One example of the impact of developing energy resources in America is the fact that North Dakota has an unemployment rate of about 3%. Why? The Bakken Formation, a geological phenomenon covering parts of North Dakota, Montana, and Saskatchewan, has an estimated 3 billion to 4 billion barrels of recoverable oil, only a tiny percentage of which has been tapped. As the state continues to recover the oil, employment grows and prosperity continues. However, even this prosperity is endangered by the Obama Administration. 

Erika Johnsen at reported that on Friday President Obama signed an executive order creating a a high-level task force to coordinate federal oversight of domestic natural gas development. What that means is that “the government is planning to regulate any energy industry we have not yet destroyed out of existence.”

The article reports:

The task force is charged with ensuring that rapidly growing efforts to tap vast natural gas supplies in the country’s shale formations, which require advanced drilling techniques including “fracking,” are “safe and responsible.”

The order seeks to find a balance between encouraging expanded domestic natural gas development, a position Obama has touted in a series of speeches in recent months, and ensuring that the administration protects the public. 

“[I]t is vital that we take full advantage of our natural gas resources, while giving American families and communities confidence that natural and cultural resources, air and water quality, and public health and safety will not be compromised,” the order says.

The Obama administration is taking new steps to increase federal oversight of hydraulic fracturing, or fracking, a drilling method that has helped usher in a natural gas boom but brought with it environmental concerns. 

The Environmental Protection Agency is slated to unveil final oil-and-gas air pollution regulations next week that would cut smog-forming and toxic emissions from wells developed with fracking. Separately, the Interior Department will soon float rules for fracking on public lands.

Unless we change the general regulation overload this administration has created, America will become a third-world country. If that appeals to you, vote for Democrats in November. If you love America and want your children to prosper, vote Republican. The future of our nation is truly at stake in 2012.

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