Shortly after the Antiplanner commented on low oil prices last April, the Saudis admitted that their goal in flooding the market with oil was to drive out high-cost producers such as owners of shale-oil and off-shore wells. Now it appears that this policy has backfired on the Saudis, as their economy is hurting from the low oil prices while the shale industry continues to produce oil.
The problem for the Saudis, says one analyst, is that low prices might hurt high-cost producers, but the shale frackers “are mostly mid-cost.” thanks partly to new technologies. This means that, once they’ve made the initial investment in drilling and fracking, they can continue to extract oil, covering their operating costs even when prices are low and won’t be put out of business by a temporary surge in production in the Mideast.
Meanwhile, the Saudi government has seen its revenues decline by more than 30 percent. This has led Standard & Poors to downgrade Saudi credit ratings, saying that the country’s economy is “undiversified and vulnerable to a steep and sustained decline in oil prices.”
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One lesson from this is that people should not count out American entrepreneurial spirit and ingenuity. An industry that people that was dying a few years ago because of shrinking supplies has turned into an economic powerhouse more stable than the Middle East.
Another lesson is that there are all sorts of warfare: cyberwar, currency wars, and other forms of economic warfare. The United States is effectively competing with Europe, Russia, Asia, the Middle East, and other regions of the world at all times, and it appears to be winning at least some of those wars. In fact, it is arguably doing better in the oil war (which is conducted by the private sector) than the hot wars in Iraq and Afghanistan (which are conducted by the government).
Thanks to the oil war, American consumers enjoy gasoline prices as low as $2 a gallon. American investors may not be getting quite the returns they expected in new oil production, but they continue to produce at near-record levels as their costs steadily decline. Russia, Venezuela, and other countries heavily dependent on oil revenues are hurting, while our highly diversified economy would barely notice even if oil producers went out of business. Saudi Arabia appears to have picked the wrong war to fight.
Thanks for the update!
But wait, where are all those believers in “Peak Oil”? That religion is now more than forty years old.
Why am I still paying $3.20 a gallon? How does the cost of gasoline correlate to the cost of oil? If oil goes from $110 a barrel to $40 a barrel, why doesn’t gas go from $4 to under $2? Are the much higher prices on the West Coast due to refinery capacity (and reformulated gasoline in CA)? Or is Big Oil involved in a conspiracy, as some have claimed?
Frank,
The cost of crude is only a part of the cost of gasoline, so changes in the price of one don’t translate to proportional changes in the price of the other. A chart shows historic changes. Here’s another chart that shows that changes in oil prices don’t lead to proportional change in gas prices.
This calculator attempts to predict gas prices based on oil prices–noting that it can take three to six months for the price of oil to affect the price of gasoline. Contrary to what I said, the calculator assumes a proportional relationship, but the numbers don’t look exactly right to me; it is probably only a first approximation. Another site estimates that a $10 change in price per barrel of oil correlate with a 25 cent change in the price of gasoline. That sounds reasonable.
Don’t forget that, while a barrel has about 42 gallons, it produces only about 19 gallons of gasoline, with the rest going to other products.
Geographic variations in gasoline prices mainly result from EPA rules about fuel formulations. Before those rules, the same gasoline could be used in every state, with price variations mainly due to transport costs and differing gas taxes. With the rules, California gasoline is not fungible with Oregon gasoline, so a small change in refinery production in California can lead to a huge change in local prices. So it is more of a government conspiracy than an oil industry conspiracy.
“Are the much higher prices on the West Coast due to refinery capacity?”
I’ve often found that gas is cheaper in the Austin area than in the Houston area. You’d think Houston would have the least expensive in the country but it doesn’t.
I also know that retailers (gas station owners) have control over setting prices. Sure, they are responding to market forces and competing with the guy across the street, but ultimately they make the final decision on the price point.
I deal with a large gasoline wholesaler. They have explained to me over the years that the various formulations (the number of which is constantly changing) often lead to spot shortages which, of course, affects price. Even in the Northeast, there are many formulations for different states depending upon whether it is winter, summer etc.
I was taking a road trip in the Midwest when that Indiana refinery shut down. The price change was almost immediate. Driving through a medium size town, the stations at the beginning of that drive were pricing regular gas @ ~$2.60. Fifteen minutes later on the other side of town the stations were charging ~$3.30. On my way back later the same day the stations that had been @ $2.60 were all above $3.00.
Goes to show that commodity prices aren’t just determined by the underlying cost of production and distribution. Rather, expectations about future supply are a big component of prices, as wholesalers attempt to purchase futures contracts for supplies. Ironically, the loss of refining capacity that led to gasoline price increases caused the price of crude to drop.
Everyone needs a cover story. I doubt the Saudi’s are just now trying to put fracking out of business. It’s possible since history is littered with established players that refused to change; maybe they just now saw the threat that fracking presents.
I suspect though it’s their cover story. Saudi Arabia isn’t a nation; it’s not a singular group of nationalities. it’s a conglomeration that the house of Saud has done a good job of holding together. But even today it’s still not a nation.
Lower oil prices will bring the Saudi national government problems. But it’ll also create funding problems for other Mid East governments ( Bahrain, Iran, etc. ) and organizations ( Al Quada in the Arabian Peninsula, ISL / ISIS, et al. ). In a country that has a perverse proportion of government jobs, SA can’t afford to lose those private sector ones. I suspect keeping production ramped up is a means of keeping up employment and trying to keep young men busy at work.
Just because they say it doesn’t mean it’s true. Everyone needs a cover story.
What has really occurred is that this most recent super cycle, the China one, is over. It’s end hasn’t been as obvious as others with a decade of severely under priced money propping up commodity prices. It’s become a bubble that, if it hasn’t already done so, will pop.
The Saudi’s with their industry low production costs and very high quality crude are milking it for as long as they can. The end of the super cycle means $20 / barrel oil, not $100 / barrel. Saudi Aramco isn’t cutting production now because they’re better off selling as much as they can at $40 / barrel rather than cutting it and having to wait another decade or two before it hits $100 / barrel. They know even if they slashed their production now, any price hike would be little more than a dead cat bounce.